Consumer Tobacco Habits Are Changing Dramatically

Like many industries, the tobacco industry is changing as consumers shift their buying habits to cheaper products in times of economic uncertainty and hardship. Unfortunately, this trading down has been compounded by the rising excise taxes on tobacco products around the world. As a result, consumers are shifting toward value brands, shunning traditionally expensive brands such as Philip Morris International's (PM 1.39%) Marlboro, sold within the United States by Philip Morris USA, a subsidiary of Altria Group (MO 0.12%).

Numbers reveal trends
While these trends are obvious, data supplied by Reynolds American (RAI) shows the scale of this 'down-trading.' Within a recent shareholder presentation by Reynolds, the company notes that since 2006, the number of premium cigarettes sold as a percentage of the overall volume of cigarettes sold within the United States has declined from slightly more than 70% to 58.6%. Meanwhile, the value segment of the market has expanded to 41.4% of the total market, up from slightly less than 30%.

What's more, Reynolds reports that the market for pipe and roll-your-own tobacco, which is generally cheaper per equivalent cigarette, has exploded over the same period. For example, during 2006 the annual sales of pipe and roll-your-own tobacco rose from 20 million pounds to an estimated 41 million pounds for full-year 2013.

Reflected in results
This trend is actually reflected within the results of both Philip Morris and Altria. Specifically, Altria reported that in the nine months ended Sept. 30, 2013, the volume of Marlboro cigarettes shipped by the company declined 3.8%. Meanwhile, the volume of 'value' brands shipped by Altria in the nine months to Sept. 30, 2013 rose by 5%.

However, this trend is much more pronounced within the global tobacco market, where Philip Morris International carries the Marlboro flag.

Global trends
To understand why this is happening, we need to do some investigating. In particular, we need to look at cigarette pricing.

Thanks to this data supplied by the Tobacco Atlas, we can see the price of the Marlboro brand in comparison to those of its local peers:

As the table shows, cheaper alternatives to Marlboro can easily be found in many markets around the world.

This is where Philip Morris is already feeling the pain. You see, peers like British American Tobacco (BTI -0.24%) have sensed an opportunity here and have driven forward with their own 'global-drive brands' priced lower than the Marlboro brand.

Philip Morris' volume of cigarettes shipped during the third quarter declined by 5.7%, led by a 2.5% decline in the total volume of Marlboro cigarettes. In comparison, international peer British American Tobacco's global-drive brands' sales grew 2.3% during the first half of this year.

For the nine months ending Sept. 30, 2013, British American reported that the volume shipped of its 'global drive' cigarette brands increased by 1.9%. The company's Dunhill brand led the increase, with volume rising 9.6%, and Pall Mall volume also rose 5.2%.

British American's four global-drive brands are Dunhill, Kent, Lucky Strike, and Pall Mall, and together their sales have expanded 62% since 2002. These four brands represent 24% of the company's total volume. Unlike Philip Morris, which is highly dependent on Marlboro, British American is nicely diversified.

Foolish summary
Economic hardship and rising excise taxes on cigarettes are two factors driving smokers toward cheaper, 'value' branded cigarettes. This is bad news for both Altria and Philip Morris, which rely on the premium-priced Marlboro for the majority of their income. On the other hand, British American Tobacco's value brands continue to take market share, and this is where the future of tobacco investing could be.