August 26, 2010 / 6:02 PM / in 7 years

Analysis - Tobacco floats new products but relies on pricing

CHICAGO (Reuters) - The growth of a new smokeless tobacco product in the United States is nothing to spit at, but cigarette companies still rely on their standard method for increasing profits -- raising prices.

The two largest U.S. tobacco companies -- Altria Group Inc (MO.N) and Reynolds American Inc RAI.N -- have been expanding distribution of snus, a type of smokeless, spitless moist snuff tobacco popular in Scandinavian countries, as they look for products to sell to smokers trying to quit cigarettes.

Snus has been a moderate hit since Swedish Match AB <SWMA.ST brought it to the United States 10 years ago, but pushing new products has not driven profits enough to shift tobacco companies' focus away from cigarettes.

Cigarette makers still count on raising prices to earn profits.

"(Tobacco companies) definitely see smokeless as a longterm piece of the business," said Morningstar analyst Phil Gorham. "But don't be fooled ... even though it's a growth category and cigarettes are in decline, it's still a small part of the overall business."

Cigarette consumption in the United States shrinks more than 2 percent each year, according to Euromonitor International data, but companies such as Marlboro cigarette maker Altria, Camel maker Reynolds and Newport maker Lorillard Inc LO.N use price hikes to compensate.

That was harder to do in the last year as Reynolds used promotions to try to grab market share, said Gorham, who follows tobacco companies at Morningstar.

Gorham expects a 3 to 4 percent price increase from all three major players this fall.

The price gap between premium brands such as Marlboro and Camel is smaller than in past years, said Stifel Nicolaus analyst Chris Growe. Because of that, he predicted increases of at least 5 cents a pack for premium brands later in the year.

Still, focussing on cigarette prices does not prevent tobacco companies from trying to increase sales volume overall, which has led to the appearance of snus (rhymes with "loose") in convenience stores and gas stations.

Swedish-style snus grew 122 percent by volume in the United States in 2007-08 and 28 percent in 2008-09, up from a small base, according to Euromonitor data.

Stockholm-based Swedish Match reported U.S. consumption of General brand snus was four times higher in 2009 than in 2008.

The overall smokeless tobacco category is growing by 6 to 7 percent a year, said Gorham, but compared with cigarettes, smokeless is tiny, and snus is even smaller.

Smokeless in total represents about 2 percent of tobacco companies' revenue; snus makes up about 0.5 percent of moist snuff sales in the United States, according to Euromonitor data.

Keep Them Hangin' on

Gorham said the role of smokeless products, and snus in particular, has been to allow cigarette makers to hang on to customers who want to quit smoking.

Companies tie snus to leading cigarette brands, pitching it as a cheaper, safer alternative to smoking and offering coupons for snus on cigarette packs.

Altria's Marlboro and Reynolds American's Camel brands have snus variants, and a partnership between Swedish Match and Philip Morris International Inc (PM.N) is being tested in South Africa. Some analysts expect Lorillard to enter the market soon.

"That really targets the smoker that wants to quit and move on to something else," Gorham said. "I don't think the purpose is really to attract a new kind of customer, it's just to prolong the period of time over which they can keep taking cash from smokers who are trying to quit."

Snus' penetration in the tobacco market is still limited. There is not much evidence of nonsmokers picking up snus, and tobacco companies have trouble selling to women and consumers with no history of smokeless use, said Euromonitor analyst Don Hedley.

Snus is banned in most of the European Union due to World Health Organisation fears that smokeless tobacco causes oral cancer.

"It's a big barrier because, apart from the U.S., where there is a smokeless tradition, EU countries, with high cigarette prices, smoking bans and high health consciousness, would have the best potential," Hedley said in an email.

Congress passed a law in 2009 that handed new regulatory powers to the U.S. Food and Drug Administration over the marketing and production of tobacco products. The new law adds uncertainty to tobacco companies that are wondering what types of new products they may be allowed to launch in the future.

The agency has tightened rules for cigarette advertising and is studying menthol cigarettes, prompting Lorillard to announce a nonmenthol version of its popular Newport brand.

Public health experts have split over whether to promote smokeless products, battery-powered electronic cigarettes -- which allow the user to inhale nicotine in a vaporized solution -- and other noncigarette products as a step to quitting smoking, said John Banzhaf, executive director of Washington, D.C., nonprofit Action on Smoking and Health.

"Do we lightly regulate and in effect encourage these other products to allow people to switch from smoking and remain forever on e-cigarettes or snus or whatever?" Banzhaf said.

"If the philosophy in the FDA is that the public health can be served by encouraging the development of snus and other products, they can write regulations that do exactly that," he said.

Altria shares were down 1.3 percent at $22.55 on the New York Stock Exchange on Thursday afternoon. Reynolds shares were down 1.1 percent at $56.04, Lorillard was down 0.5 percent at $77.61 and Philip Morris was down 0.9 percent at $51.05.

Reporting by Emily Stephenson, editing by Matthew Lewis

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