Bargain Shopping Cigarette Smokers Cause Problems for Big Tobacco

As Americans look for ways to save money, they are increasingly turning to cheaper brands of cigarettes. This presents a challenge for major tobacco companies, who must decide whether to protect their profits or lose market share to the budget brands.

British American Tobacco's stock is down 2.65%.

Altria, the manufacturer of Marlboro cigarettes, said on Thursday that more U.S. smokers are switching to cheaper brands of cigarettes. Altria's share price fell 0.97% on the news.

When it recently reported third-quarter results, [COMPANY] pointed out the same trend.

Tobacco sales have been relatively stable during previous economic downturns, but smokers are sensitive to inflation as they have lower incomes than the average consumer. In the U.S., smoking prevalence among people earning less than $35,000 a year is around 21%, compared with just 7% for those earning more than $100,000.

The cost of gasoline has fallen from summer highs, which is helpful for the tobacco industry. Prices at the pump have a big influence on volumes of cigarettes sold in the U.S., but rising food and housing costs are forcing smokers to find new ways to save money. Cheaper tobacco brands increased their share of the U.S. cigarette market to 27.1% in the third quarter of 2022, up 1.8 percentage points from a year ago.

BAT and Altria both have a range of brands in their portfolios, allowing them to target different income groups. On average, BAT’s Newport cigarettes cost around $8 a pack, while the Lucky Strike brand is closer to $5—though taxes cause big variations between states. However, they still have to watch price gaps that are opening up with smaller rivals. In the third quarter, a pack of Marlboro cost $8.32, which is 40% more expensive than the cheapest competitor, Altria said. Three years ago, this price premium was 31%.

The trend favors smaller players like New York-listed Vector Group. In the third quarter, the company sold 30% more cigarettes than the same time last year. Part of the boost came from Korean rival KT&G leaving the U.S. market altogether, but consumers’ down-trading also helped. Imperial Brands, which has a big portfolio of discount cigarette brands in the U.S., is also gaining market share.

Vector Group has an advantage that makes it hard for big tobacco firms to fight back. Big cigarette companies have to pay billions of dollars every year as part of the 1998 Tobacco Master Settlement Agreement that compensates states for health-care costs linked to smoking. However, Vector Group has a relatively small share of the market, which exempts it from having to pay into the MSA. This helps it to keep prices low.

BAT and Altria need to retain high profits in their legacy cigarette businesses in order to fund expensive investments in less-harmful products like vape pens and heated tobacco sticks. A price war that could eat into margins is unappealing, but so is losing business. The companies need to strike a delicate balance as smokers come under pressure.