All Of A Sudden, Lorillard Could Lose Its Leadership Position In E-Cigarettes

Aug.18.14 | About: Lorillard, Inc. (LO)

Summary

Lorillard's Blu brand saw sales decline by 35% last quarter.

Competitors like Altria are ramping up production of their own e-cigs.

Lorillard has decided to sell Blu and go with Reynolds American's e-cig brand, which is a questionable strategic bet.

It's easy to think tobacco giant Lorillard (NYSE:LO) is far and away the best bet on electronic cigarettes. Electronic cigarettes, or "e-cigs" as they are more commonly known, present an exciting opportunity in an industry that gets a lot of criticism for lacking in new avenues for growth. Over the past few years, e-cigs have emerged as a popular alternative for smokers.

In turn, tobacco companies like Lorillard jumped on the opportunity. Lorillard has made a series of investments over the past few years to plow heavily into the category, through its acquisition of Blue in 2012, and U.K.-based SKYCIG last year. As a result, it enjoys a dominant market position. But for how long, is questionable at best.

But that's all about to change. As part of its merger with Reynolds American (NYSE:RAI), Lorillard will ship its flagship Blu brand to Imperial Tobacco (OTCQX:ITYBY). Meanwhile, Altria (NYSE:MO) is starting to make a big splash in the e-cig category.

All this calls into question Lorillard's strategy, and its decision to ditch one of its most successful brands.

Competition in e-cigs is heating up

As a result of its acquisitions, Lorillard has built a large e-cig business. As of the end of the last quarter, Lorillard held a 41% market share in the United States. But this has come down considerably over the past few months. In the previous quarter, Lorillard held nearly half the market share.

Lorillard is now facing intense competition from the likes of Altria and others. Altria was slower into the e-cig category than Lorillard, but it seems its decision to wait and keep developing its product may be a wise one. Altria's e-cig product has some unique features that could someday place it at the top of the industry.

Altria initially rolled out its e-cig brand, MarkTen, in just two states, Indiana and Arizona, but after promising test results, Altria is taking its brand national. Altria believes its proprietary technology will be favored by consumers. The company maintains that its "FourDraw" technology provides a better user experience and noted that the MarkTen brand was quickly adopted in its initial test markets. MarkTen has now achieved distribution in over 60,000 retail stores in the Western part of the United States.

Altria supplemented its portfolio by purchasing Green Smoke Inc. for $110 million earlier this year. Green Smoke has a strong presence in online sales, and should be able to grow even faster now that it has Altria's superb distribution capabilities at its disposal.

This is already having an effect on Lorillard, which suffered an alarming 35% decline in sales of e-cigs last quarter.

Ditching the category-leading brand is a risky bet

As part of the agreement to be acquired by Reynolds American, Lorillard is shipping a number of brands over to Imperial Tobacco. These include Kool, Salem, Winston, and Blu.

Going forward, Lorillard and Reynolds American will develop Reynolds' own e-cig brand, Vuse. Like MarkTen, Vuse was debuted in two states at first, then expanded across the nation. Lorillard must have high hopes for Vuse, since it's willing to sell off the industry leader by far.

This is a questionable strategy. Although Blu did see a sharp drop in sales last quarter, it still held the dominant market position. Simply walking away from Blu could backfire, and seems like a big risk to take. Electronic cigarettes are a booming industry and represent one of the only growth opportunities to come across the tobacco sector in a long time.

Lorillard is placing all its eggs into the Vuse basket. MarkTen is making big progress, and will take advantage of the distribution capabilities of tobacco juggernaut Altria. Before long, Lorillard might see its former status as the e-cig industry leader quickly erode.

Disclosure: The author is long MO. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.