Did This Study Just Quash the E-Cigarette Market?

A new study came out against the effectiveness of e-cigarettes as smoking-cessation devices. What does it mean for Altria Group, Reynolds American, and Lorillard?

Mar 31, 2014 at 5:30PM

One of the major selling points for electronic cigarettes, or e-cigarettes, is that they are effective smoking-cessation devices. Altria Group (NYSE:MO), Reynolds American (NYSE:RAI), and Lorillard (NYSE:LO) have made bets that smokers will switch to e-cigarettes as a healthier alternative to traditional cigarettes. However, that thesis may have just gone up in smoke, as new research suggests that e-cigarettes are not an effective smoking-cessation device.

Questions about e-cigarettes' effectiveness
The study, published in JAMA Internal Medicine, followed a nationwide sample of 1,549 participants for one year. It discovered that e-cigarette use did not result in a change in cigarette consumption.

This is mixed news for the tobacco industry, which is threatened by the potential for e-cigarettes to become an effective substitute for traditional cigarettes. However, Altria, Reynolds, and Lorillard are also positioned to reap the majority of the benefits from the e-cigarette boom. Lorillard acquired e-cigarette leader Blu in 2012 for $135 millon; it now has a nearly 50% market share. Reynolds and Altria are also rolling out e-cigarette brands nationwide this year.

Big tobacco's move into the e-cigarette market is as much a defensive stance as an attempt to boost profitability. Respected tobacco analyst Bonnie Herzog predicts that U.S. e-cigarette consumption will surpass that of traditional cigarette consumption within the next 10 years. Since much of the growth in e-cigarettes comes at the expense of traditional cigarettes, tobacco companies are merely playing defense.

However, there is widespread fear among anti-tobacco activists that e-cigarettes could make smoking cool again and serve as a gateway to cigarettes. A study published in JAMA Pediatrics found that e-cigarettes contributed to teenage nicotine addiction. E-cigarettes, which come in flavors like cherry, strawberry, and cookies & cream, are less harsh than cigarettes, making it easier for adventurous teenagers to pick up the habit. Moreover, the study showed that current smokers who had never used e-cigarettes were more determined to quit than those who had used e-cigarettes. Although scientists are far from reaching a consensus on the issue, these findings could put a damper on e-cigarette growth.

The Food and Drug Administration has not yet released comprehensive guidelines for e-cigarette regulation, but many states and municipalities are already clamping down on the tobacco-free devices. Bills in New York, Oregon, New Jersey, Washington, and a number of other states have proposed taxing and regulating e-cigarettes like other tobacco products. High taxes, marketing restrictions, and public awareness about the health risks associated with smoking tobacco have led to a long-term secular decline in cigarette consumption in the U.S. The same factors could put a lid on e-cigarette growth.

What it means for tobacco companies
Altria has the most to lose from e-cigarette growth. It was the last of the big three U.S. tobacco companies to announce a nationwide rollout of its e-cigarette brand, and its 50% share of the U.S. cigarette market gives it a dominant share of the industry's profits. Stunted e-cigarette growth would reaffirm Altria's dominant position in the industry.

Reynolds is in the same boat as Altria. Its Vuse e-cigarette has yet to gain wide adoption, while its Camel and Pall Mall brands combine for a 17.8% share of the cigarette market. All of the company's brands combine for a 26% share of the cigarette market.

Lorillard, on the other hand, could stand to gain another revenue source. Its revenue is largely dependent on Newport menthol cigarettes; Newport (mentholated and non-mentholated) accounts for 85% of Lorillard's cigarette volume. Given pending legislative restrictions on menthol cigarettes, Lorillard's small-but-growing e-cigarette business is an important source of diversification.

Nobody knows how e-cigarettes will be regulated; the rules have yet to be drawn up. However, Altria and Reynolds would not mind it if e-cigarettes were lumped in with tobacco products; the two leading tobacco companies have a lot more to lose from e-cigarette growth than they could hope to gain. Lorillard, on the other hand, stands to gain a meaningful new source of revenue if it can maintain a dominant share of a growing e-cigarette market. It is too early to tell which way regulators will go, so tobacco-industry investors must accept a high degree of uncertainty for the time being.

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4 in 5 Americans Are Ignoring Buffett's Warning

Don't be one of them.

Jun 12, 2015 at 5:01PM

Admitting fear is difficult.

So you can imagine how shocked I was to find out Warren Buffett recently told a select number of investors about the cutting-edge technology that's keeping him awake at night.

This past May, The Motley Fool sent 8 of its best stock analysts to Omaha, Nebraska to attend the Berkshire Hathaway annual shareholder meeting. CEO Warren Buffett and Vice Chairman Charlie Munger fielded questions for nearly 6 hours.
The catch was: Attendees weren't allowed to record any of it. No audio. No video. 

Our team of analysts wrote down every single word Buffett and Munger uttered. Over 16,000 words. But only two words stood out to me as I read the detailed transcript of the event: "Real threat."

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KPMG advises we're "on the cusp of revolutionary change" coming much "sooner than you think."

Even one legendary MIT professor had to recant his position that the technology was "beyond the capability of computer science." (He recently confessed to The Wall Street Journal that he's now a believer and amazed "how quickly this technology caught on.")

Yet according to one J.D. Power and Associates survey, only 1 in 5 Americans are even interested in this technology, much less ready to invest in it. Needless to say, you haven't missed your window of opportunity. 

Think about how many amazing technologies you've watched soar to new heights while you kick yourself thinking, "I knew about that technology before everyone was talking about it, but I just sat on my hands." 

Don't let that happen again. This time, it should be your family telling you, "I can't believe you knew about and invested in that technology so early on."

That's why I hope you take just a few minutes to access the exclusive research our team of analysts has put together on this industry and the one stock positioned to capitalize on this major shift.

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David Hanson owns shares of Berkshire Hathaway and American Express. The Motley Fool recommends and owns shares of Berkshire Hathaway, Google, and Coca-Cola.We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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