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Summary

  • Anecdotal observation shows the emergence of many new e-cigarette stores, some taking the place of former gold-buying stores;
  • E-cigarettes have many advantages over traditional tobacco, so are likely to take away significant market share. The new stores indicate an acceleration of this trend;
  • Big tobacco is entering the e-cigarette segment, however this segment is more fragmented and lower margin than traditional tobacco, so the shift will be negative for big tobacco.

Around one year ago, I wrote an article titled "Gold Speculators Are Being Fed". In it, I explained that anecdotal observation was similar to what had happened in the previous gold (NYSEARCA:GLD) bubble back in the early eighties. The anecdotal observation was regarding the huge increase in the number of gold-buying stores. Since then gold has performed poorly.

So poorly, in fact, that many of these gold-buying stores are now closing; be it due to lower volumes or to lower pricing, the fact is that the business is no longer as attractive. A new kind of store, however, is cropping up everywhere, sometimes even in the very places where gold stores close. The new kind of store is a store selling e-cigarettes.

This development doesn't mean much for gold, but it does have meaning for the tobacco industry. I had already written on how e-cigarettes were a threat to tobacco, but this development means that the threat is finally materializing. In all likelihood, the physical availability of e-cigarettes along with their massive advantages is going to take a large bite out of traditional tobacco.

Just as a reminder, e-cigarettes are:

  • Cheaper;
  • Less harmful;
  • More diverse in terms of flavor;
  • Sometimes allowed where smoking is forbidden;
  • Don't leave a stink in your clothes or home/car;
  • Lead to better breathing in the short term;
  • Allow for the return of the sense of taste;
  • And are even the basis for a new collectible industry, given their diversity.

E-cigarettes thus have many reasons to take market away from tobacco. Tobacco was already seeing lower usage due to its health impact as well as an unfavorable social image. For a while the size of the e-cigarette industry was too small to impact tobacco companies, but that seems likely to change quickly in the coming years, given this new commercial dynamic.

Tobacco is an oligopoly

Tobacco has long been an oligopoly dominated by a few large companies, including Lorillard (NYSE:LO), Phillip Morris (NYSE:PM), Reynolds American (NYSE:RAI), British American Tobacco (NYSEMKT:BTI) and Altria Group (NYSE:MO).

The impact from e-cigarettes will be amplified by the fact that big tobacco is an oligopoly, whereas the e-cigarette industry isn't. Big tobacco companies have been able to mitigate lower tobacco usage by increasing prices, but it now seems likely that e-cigarette usage will erode tobacco volumes at an accelerated rate.

Even though large tobacco companies are trying to enter the e-cigarette market, the fact is that the industry will go from an oligopoly of high-margin products to a highly-competitive, dispersed, industry with hundreds of players and low-margin products. For established tobacco companies this dynamic is highly unfavorable.

On the other hand

Instead of being interested in knowing that the present situation is dangerous for the quoted big tobacco companies, one might wonder if there's any way to try and take advantage from it from the long side. There is a small, quoted, e-cigarette company: Vapor Corp (VPCO); I actually highlighted it more than 2 years ago in an Instablog. At the time it had less that 1/10th the market capitalization it has today.

But the problem is, the fragmented and low-margin industry cuts both ways. It not only makes the big tobacco companies dangerous, it also makes the small competitors like Vapor Corp dangerous as well. There are hundreds of these companies competing in the market, and most will be losers. The market growing exponentially won't change that, so betting on Vapor Corp at this point and with the fundamentals it shows is highly speculative.

Sure enough, the present stock market is highly speculative to begin with and people are betting left and right on tech companies with billions of dollars in market capitalization and no net profits to show the world. But I'd have trouble recommending such an approach, even though Vapor Corp presently has just $134 million in market capitalization. I called it a long shot at $12 million, but here it's already a different ball game. Anyway, for those interested in the long side of the e-cigarette trend, albeit speculative as it is, it might merit consideration.

Conclusion

Over the last year, I've been noticing an explosion in e-cigarette stores. I've seen them crop up in several different European countries and know the same is happening in the U.S. This physical presence will probably accelerate the adoption of e-cigarettes. Since the overwhelming majority of e-cigarette users are former smokers, this new trend will likely impact and accelerate the demise of tobacco.

While the large tobacco companies will try to enter this market, this market is more fragmented and has much lower margins when compared to traditional tobacco. This means that the shift towards e-cigarettes must necessarily be very negative for existing tobacco companies.

Source: Anecdotal Evidence - Gold And Cigarettes