The impact of falling cigarette demand in recent years has put paid to the tobacco sector’s reputation as one of the go-to destinations for dependable earnings expansion. To reclaim its lustre with growth-hungry investors, however, British American Tobacco (LSE: BATS) and Imperial Tobacco Group (LSE: IMT) have ploughed vast resources into building their position across the next generation of consumer-friendly stimulants, none more so than in the vapour market.
Both firms’ entry here has been touted with much fanfare, and with good reason. Analysts at Wells Fargo expect worldwide sales of e-cigarettes and other vapour-based products to reach $7bn this year, driven by demand in the US, which is anticipated to hit $3.5bn by the end of the year and possibly $10bn within five years.
This news bodes particularly well for Imperial Tobacco, whose purchase of the blu vapour brand from Reynolds American last summer gives it access to the most popular e-cigarette brand in the US. British American Tobacco is also ploughing vast reserves and product development to boost the rollout of its Vype product across the globe.
Looking further afield, Imperial Tobacco made its maiden foray into the caffeine strip market last month by trialling sales of its Reon products online and in shops across Manchester. The company is hoping its products will enjoy the same explosive growth seen in the energy drinks market and embodied by the success of Red Bull.
Combustible market to post long-term recovery
But this is not to say demand for traditional, combustible products are dead in the water, even though a perfect storm of rising regulatory pressure, increased health concerns and a surging black market are all pushing volumes lower. British American Tobacco announced a 1% decline in physical off-take during January-September, while Imperial Tobacco reported a 7% fall for the 12 months concluding September.
However, I believe that the terrific pricing power of these firms’ industry-leading labels — which include British American Tobacco’s Lucky Strike and Pall Mall, and Imperial Tobacco’s Davidoff and West — should still deliver long-term revenues growth. Indeed, both companies are placing an increased focus on developing and advertising these brands, labels that continue to comfortably outperform the wider market.
On top of this, I believe that rising spending power in critical developing markets like Asia and Latin America — home to the lion’s share of the world’s smokers — should drive sales through the roof in the coming years, particularly once current cyclical headwinds abate.
Grocery gurus on their knees
However, I believe that the growth prospects of Britain’s largest supermarket chains remain much more subdued by comparison.
The effect of surging competition at home has seen the checkouts at Tesco (LSE: TSCO), Sainsbury’s (LSE: SBRY) and Morrisons (LSE: MRW) fall increasingly silent as both the discounters and high-end outlets punch record market shares month after month. Aside from the introduction of profit-crushing price cuts across the store, none of Britain’s listed grocery specialists have come up with a strategy to counter the competition and get sales marching higher again.
Furthermore, the supermarket giants have also failed to convincingly embrace hot growth markets. The decision of Sainsbury’s to engage the fast-growing budget space by building an alliance with Netto is a step in the right direction, but plans to open a grand total of 15 stores is unlikely to get hearts racing, particularly as Aldi and Lidl ramp up their own expansion plans.
It is true that these firms are stepping up their efforts in the promising online and convenience store sub-sectors, and Morrisons took the decision to throw its hat into this particular ring last January. But with these areas becoming more and more congested, there is no guarantee that the rising popularity of such channels will be enough to resuscitate earnings growth any time soon.
