The global cigarette industry has been in decline for the last five years. Cigarette demand peaked in 2012 with around six trillion cigarettes being consumed worldwide. Since then, the volume of consumption has declined by 9.2% (CAGR -1.9%) to 5.4 trillion cigarettes in 2017. The decline in volume has been driven by a number of factors including rising regulation, higher excise duties, growing consumer health consciousness as well as the availability of cheaper alternatives.
The average price of a pack of cigarettes in the UK for example has risen by 86% over the last 10 years, reaching £9.97 in 2018, with the majority of the price increase coming from excise duties. The ever-increasing cost of smoking is one of the leading reasons why some choose to quit. Smoking rates in the US and UK are currently at their lowest levels in years, at 15.5% and 15.8% respectively, measured as a percentage of total population.
Vaping has become a popular alternative for smokers seeking to quit the habit, not least because the cost of maintaining a vaping habit is considerably cheaper than traditional smoking. A 30ml bottle of vape liquid (juice) costs £10 on average and typically lasts between one to two weeks, depending on the frequency of use. By comparison, someone with a smoking habit of 20-a-day will be spending around £70 per week on cigarettes.
The global vape market is currently valued at US$22.6bn and is estimated to grow to US$61bn by 2025, representing a compound annual growth rate of 15.4%. The US and UK are the leading vape markets globally, with 3.7% and 5.6% of their respective populations using e-cigarettes.
Growth in vaping will benefit global tobacco companies such as British American Tobacco (BATS) and Philip Morris, as they own many of the largest vape brands. BATS has a 40% market share of the UK vaping market, the second largest vape market globally after the US, with its vape brands Vype and Vuse.
Although BATS has a significant share of the global vaping sector, the vape market is still only a fraction of the size of the traditional cigarette market, where sales totalled nearly US$700bn in 2017. The vaping market remains fragmented, with the majority of participants being small to medium sized private companies. Barriers of entry into the market are very low due to the relatively small initial outlay of capital required to produce or supply the juices and devices.
The substantial cost savings afforded by vaping have been a major driver of its popularity in recent years. However, vape products are not currently taxed in the same way as tobacco products. If governments decide to apply a similar level of excise tax to vape products, there is a risk that vaping margins will deteriorate if the additional costs are not passed on to the consumers.
We estimate that the margins for vaping devices and liquids are substantially lower than traditional cigarettes. As a result, we think rising demand will likely have a dilutive impact on BATS’ margins. BATS does not currently disclose the financial performance of the vaping business, which we estimate to be loss making currently.
As the vape market has expanded, so has product regulation and questions on nicotine content based taxes. In 2016, the US Food and Drug Administration (FDA) extended its regulatory power to include e-cigarettes, which it deemed to be tobacco products. Regulation on vaping varies from country to country, with some countries having no regulation whatsoever, and others banning vape devices and liquids altogether.
Some Asian countries such as Japan and Thailand have banned the sale and use of liquids containing nicotine, which has led to the increased adoption of Heat not Burn (HnB) tobacco devices, particularly in Japan. As regulation surrounding vaping evolves, so will the vape market and its constituents, along with the risk that profits will erode further should excise duties be imposed or if vape product advertising is banned.
Vape products have only been available to the mass market for a relatively short time, meaning the long-term health risks or benefits are still unknown. While vaping ‘smoke’ does not produce many of the harmful substances contained within tobacco smoke, such as tar or carbon monoxide, it does still contains nicotine, which remains a highly addictive and regulated substance in most countries.
Numerous studies have been conducted to determine how much safer vaping really is when compared to smoking tobacco. The majority of studies concluded that vaping lowers the number of toxins and carcinogens ingested when compared with smoking or chewing tobacco. As a result, many health bodies, including the UK’s NHS, have recommended vaping as a way to quit smoking. They state that although vaping isn’t completely risk free, it carries a lower risk than smoking conventional cigarettes.
Although vaping is considered less unhealthy than smoking, ingesting any foreign carcinogen will still have detrimental effects on the lungs and respiratory system, which raises the question, is there such a thing as safe levels of carcinogens? That said, the evidence appears clear that vaping is a better alternative for smokers who either don’t wish to quit smoking, or those trying and potentially failing to quit cold turkey.
Vaping has also become popular among younger people, particularly in the US. The use of sweet flavours such as fruits as well as the ease of purchasing the devices online has resulted in a sharp increase in the use of e-cigarettes. In a 2016 report conducted by the US Surgeon General, it noted a 900% increase in vaping by high school students between 2011 and 2015.
The alarming rise in under-age vaping use in the US has prompted the FDA to pay close scrutiny to the vaping market. With a plethora of potential restrictions available to them, we do expect the FDA to introduce new regulations in due course.
As and when vaping becomes more mainstream, the regulation surrounding the products will be increased. Whether those additional costs of adherence will be passed down to the customers, is yet to be determined.
The rapid growth of the vaping industry has been a double edged sword for large tobacco companies. On one hand, the popularity of vaping has provided much needed growth within the industry, but at a cost, given the margin dilution. Rising demand for vaping has also resulted in cannibalisation from the traditional cigarette businesses, exacerbating the size and speed of volume declines within factory made cigarettes.
As a result, we do not expect the rising demand for vaping to arrest the long-term decline in the global tobacco industry.
Shane De La Haye, assistant fund manager at Ashburton Invesments