Don’t Blow Off Cigarettes

David Bennett
June 11, 2015
CSDecisions
Cigarette sales have been steadily declining, but the category is too big to ignore and too lucrative to disappear any time soon.
By David Bennett, Senior Editor
Since cigarettes sales have been slowly falling the last few years, convenience retailers have invested in foodservice and other ventures to help balance in-store revenue—which seems a wise move, according to industry indicators. From 2010 to 2013, the total volume of cigarettes sold within the U.S. declined at a compounded annual rate of 3.5%.
Those figures are attributed most to the diminishing number of smokers nationwide.
However, as fuel prices have fallen, consumer spending on cigarettes has been on the upswing, going to show the cigarette category doesn’t need help to survive—just some economic boosters to thrive.
Convenience stores last year were the dominant channel for cigarette sales, garnering an 86.9% share of cigarettes sold in 2014, compared to a 6.7% share for grocers and drugstores, which captured 6.4% of the category, according to the latest State of the Industry data from the National Association of Convenience Stores (NACS). NACS’ report indicates that in 2014, the cigarette category was the top merchandise performer by sales dollars per store, per month.
Looking at gross margin dollars, cigarettes—including standard and generic brands—were second only to packaged beverages as the top merchandise category.
THEN THERE WERE TWO
U.S. cigarette profits are substantial and will remain so as big tobacco companies seek to capture more market share from each other. In July 2014, Reynolds American Inc., parent of R.J. Reynolds, announced it would buy Lorillard Inc., the third largest tobacco company in the U.S., for $27.4 billion. The companies will merge Reynold’s flagship brands, Camel, Pall Mall and American Spirit cigarettes, with Lorillard’s portfolio of Newport menthol-flavored cigarettes.
Though Lorillard’s electronic cigarette success story—blu eCig—was part of the package, electronic cigarettes weren’t the main draw for R.J. Reynolds, according to some analysts. The tobacco maker quickly spun off blu and sold the brand to Imperial Tobacco Group Plc. At that time, blu was the best-selling electronic cigarette brand in the country, accounting for 47% of the market.
Also, R.J. Reynolds was preparing to roll out its own ecig brand, Vuse.
Still, the merger deal makes Reynolds American the second largest tobacco company in the U.S. after Altria Group Inc., maker of Marlboro cigarettes. That sizeable jump in market positioning isn’t lost on the c-store industry, which is watching for what happens next.
Mike Gancedo, tobacco category manager for Savannah, Ga.-based Parker’s chain of 40-plus convenience stores in Georgia and South Carolina, predicts that the technology that made Camel Crush a popular line over the last few years might be applied to Lorillard brands, thus creating more flexibility in their product mix.
“I do expect R.J. Reynolds to do something with the Crush technology for Newport,” Gancedo said. “The Crush technology has been a huge success for R.J. Reynolds and its growth on premium has come from the Camel Crush family, so it shouldn’t come as a surprise to see them roll out a Newport Crush line extension.”
Of course, c-stores are keeping an eye on pricing hikes that are being rolled out as well.
Altria last month announced its intention to raise list prices across its cigarette portfolio by seven cents per pack—70 cents per carton—or approximately 2-3%, across its entire platform of core brands. Those increases went into effect May 17.
For its Marlboro Leadership Price (MLP) program customers, PM USA was offering an eight-cents-per-pack promotional allowance on Marlboro for a limited time.
“Phillip Morris and R.J. Reynolds announced manufacturer price increases by 70 cents per carton so we will have to go up slightly on our retails, however I do not see this affecting our volume,” Gancedo said.
“The majority of our competition has gone with (MLP), we have decided that we are not and we have been able to maintain our volume due to our aggressive multipack pricing on three packs.”
GAS AND UPGRADES
Of course lower fuel prices and a humming economy is spurring opportunity in the category. At many c-stores, manageable gas prices and higher wages have led smokers to trade up to premium-priced cigarettes, including at Parker’s locations.
“We have actually seen an increase on our Premium business due to this,” Gancedo said. “It looks like people have a few extra dollars in their pockets due to the lower gas prices and they are trading up.”
Stacie Tonniges is the cigarette and tobacco category manager for Casey’s General Stores Inc., a publicly-traded chain operating nearly 1,900 convenience stores in 14 states in the Midwest.
With economic conditions continuing to favor the category, Tonniges expects positive performance results, at least for the next couple of months.
“We believe that cigarette and tobacco sales will continue to perform well in the first half of 2015,” Tonniges said. “We feel that we have the correct marketing mix in place to ensure that our customers are satisfied.”

HEALTH AND WELLNESS
Another catalyst that can be linked—albeit indirectly—to bolster cigarette sales in c-stores was CVS Health decision last year to halt sales of tobacco products at its 7,000 pharmacies. CVS Health explained that eliminating tobacco was in line the company’s broader mission of improving consumer health.
Recent reports, however, assert that CVS Health is creating new drug plans that charge higher co-pays for scripts filled at retailers that sell tobacco, prompting other drug retailers to follow suit.
CVS is one of the biggest pharmacies and the largest pharmacy services provider in the U.S. The company also has strategic alliances with healthcare service companies like Dublin, Ohio-based Cardinal Health.
Cardinal Health is parent to Medicine Shoppe International, which operates Medicine Shoppe and Medicap Pharmacy locations in the Midwest. Medicine Shoppe said in a statement recently that when managed-care organizations began penalizing patients who utilize pharmacies that sell tobacco products with increased co-pays, the franchise system and its franchisees implemented a formal policy prohibiting sales of tobacco and tobacco-related products.
David Bishop, managing partner at Barrington, Ill.-based analysis firm Balvor LLC, said if more retail pharmacies forgo tobacco sales, some of that spill-over could benefit c-stores that operate in close proximity to those pharmacy locations.
“When CVS made the decision to exit, they actually restructured their pharmacy contracts and those contracts went into effect Jan. 1, 2015,” Bishop said. Because of those contracts, more pharmacy retailers who partner with CVS will also sacrifice their tobacco revenue stream, Bishop predicted.
“What you are going to see more retailers in those (drug) channels announcing they are no longer going to sell tobacco. At that time it will become eventually clearer to people that what’s driving (cigarette) growth in convenience retail isn’t so much CVS’ immediate, direct exit, but rather the fallout that’s the consequence of a strategic change that CVS put in its contracts with all of its pharmacy network providers.”
For now, Tonniges said the result is in the register.
“At Casey’s, we have seen an increase in our cigarette sales where we have a store located within two miles from a CVS location.”
TAKING TAXES
For all the circumstances that are benefiting the cigarette category, many state lawmakers are waiting in the wings with proposed tax bills to close revenue leaks in their budgets.
According to The Tax Foundation, a nonpartisan research think tank based in Washington, D.C., at least 30 states and the District of Columbia have raised cigarette tax rates between 2006 and 2013. So far this year, several states are looking to place higher tariffs on cigarettes, including:
• Alabama legislators are calling for an additional 82-cent tax on every pack sold in the state. The new rate per pack would total $1.25. Alabama’s current cigarette tax rate is 42.5 cents per pack.
• California lawmakers and health organizations are pushing legislation that would increase the state tax on cigarettes by $2 per pack. Current California tax on a pack of cigarettes is 87 cents.
• The Kansas governor has proposed a $1.50-per-pack cigarette tax boosting the Kansas cigarette tax to $2.29 a pack.