Without a doubt, 2020 was a great year for cigarettes. Even though just 16% of the U.S. adult population smoked as of 2019, cigarette sales didn’t experience the same declines in 2020 that have been typical of recent years. Sales grew by 3.6%, according to the NACS State of the Industry Report of 2020 Data (SOI).
This uptick in sales was a bright spot for convenience retailers, especially given the importance of the category to a c-store’s overall sales and profit. In 2020, cigarettes again represented the largest contributor of in-store sales (27.79%) and were third in terms of in-store gross margin (13.92%), falling behind prepared food (21.97%) and packaged beverages (19.02%).
“Sales and profit increases from 2019 to 2020 were largely attributed to increased consumption throughout lockdown and work from home,” said Jayme Gough, NACS research manager.
But the question is: What happens to cigarette sales as the country slowly eases back to normal?
Source: NACS State of the Industry Report of 2020 Data
Next to Normal
In looking at monthly CSX sales data, Gough said 2021 has tracked pretty closely to 2020’s numbers.
“It’s hard to tell at this point,” she said. “Looking at July, we were a little lower than last year in terms of monthly sales, but then we were a little bit higher in March than last year. It might even out in the end.”
These data suggest that convenience cigarette sales will ultimately be flat or slightly up in 2021—a net win for the channel, given the tough comps to 2020.
“Last year’s 3.6% sales increase year over year was pretty huge for cigarettes,” she said. “I would consider it a win for the category if we were flat because that means we kept that 3.6% sales growth from the previous year.”
Subcategory Performance
Just as stay-at-home orders and remote work helped the cigarette category in 2020, a slower-than-anticipated return to normalcy has likely allowed retailers to keep those increased cigarette sales in 2021. Despite vaccinations, as of July, building security company Kastle Systems reported that only 32% of office workers had returned to large office buildings. NACS data tell a similar story, with store transactions up 7% for midyear 2021 versus midyear 2020—but transactions are still not back to pre-pandemic levels.
“I don’t think we can say it’s even close to normal yet,” Gough said.
“Normal” may prove to be a relative term in the post-pandemic world. A survey by the National Association for Business Economics found that just 11% of companies expected all staff members to return to full-time, in-office work in 2021, and a global employee survey by market research firm Ipsos found that nearly two-thirds of respondents want flexibility in the amount of time they go into the office.
While not a universal win for the cigarette channel, a more permanent shift toward working from home would likely benefit the cigarette category.
“Because convenience caters to so many lifestyles, there are some categories that are obviously going to benefit from people returning back to the office and the commute,” Gough said. “But with cigarettes, beer, wine and liquor, some of those categories benefited from consumers being at home more.”
Increasing Prices, Downtrading Pressures
In terms of cigarette subcategory performance, premium cigarettes tend to drive how the category performs given that they accounted for 77.5% of cigarette sales in 2020. Premium cigarettes, like cigarettes overall, have been more or less flat this year.
Subgeneric/private-label cigarettes, while just 12.1% of the category, have been “a lot more interesting,” according to Gough.
“It was a breakout starting at the end of 2020 and has continued so far into 2021,” Gough said of the segment. Monthly sales for the subcategory so far in 2021 have averaged nearly $4,000 per store per month, higher than any other year going back to 2018.
Sales and profit increases from 2019 to 2020 were attributed to increased consumption throughout lockdown and work from home.
“Consumers have realized that they don’t need to sacrifice quality to get a less expensive product,” said Jessica Fratarcangelo, marketing director for Cheyenne International. “Whether the consumer is becoming more educated about the cigarette category as a whole, or trading down due to recent economic pressures, we find that deep discount cigarettes can deliver what the consumer desires at a reasonable price, while still providing retailers with attractive penny profit.”
One reason for the increase in subgeneric/private-label sales could be more frequent price increases leading to downtrading pressure on price-sensitive consumers. This year, most major cigarette manufacturers have adopted a quarterly price increase.
“We continue to expect stepped up price increases, especially in light of a potential for a state and federal excise tax increase,” Goldman Sachs Analyst Bonnie Herzog wrote in a research note.
While those price increases were largely across all segments, they may have boosted the appeal of lower-priced options.
“Across the board, in general last year, shoppers were more wary about spending, especially with unemployment being so high,” Gough said.
Retailers that took part in Goldman Sachs’ quarterly “Nicotine Nuggets” survey agreed, with 65% reporting the cigarette downtrading picked up in the second quarter of 2021.
“Unsurprisingly, respondents broadly agree that downtrading trends have moderately picked up in the second quarter versus the first quarter as government stimulus money dries up and increased spending options with the reopening, which puts pressure on wallets and given the increased frequency and strength of cigarette price increases,” Herzog said.
Federal Regulations Loom Large
Regulations have always played a big role in the cigarette category, and 2021 was no exception. The difference is who is passing those regulations.
In recent years, most onerous legislation—menthol bans, taxes, retail license limitations—has happened at the state and local level. Before 2020, on a federal level, things had remained relatively stable. This year, cigarette retailers are bracing for (at least) a trio of proposed federal regulations with the potential to upend the category: a 100% increase to the federal excise tax, a complete ban on menthol cigarettes and a lowering of the allowable amount of nicotine in cigarettes.
Getting the most traction in Congress this year is legislation to increase the federal excise tax. The Tobacco Tax Act, first proposed by Senator Dick Durbin (D-Ill.), wouldn’t just double the federal tax on cigarettes, it would also apply it to other forms of tobacco and nicotine. While the legislation didn’t gain traction as a solo bill, House Democrats originally included it as a funding source for their reconciliation package. However, given the strong pushback from retail businesses and consumers, they removed the FET increase of tobacco products in their final version of the Build Back Better Act but left a tax on vape. Their bill proposes taxing vape, which is not currently taxed federally, based on the volume of nicotine. In many cases, this would tax vape at a rate even higher than cigarettes. As of the time of this writing, the package has not yet been brought to the House floor for a full vote, and the Senate is currently drafting its own version of the reconciliation package, according to NACS Director of Government Relations Anna Ready Blom.
“Exorbitant increases in tobacco and nicotine taxes have unintended consequences as we have seen at the state level and in other countries,” Ready Blom said. “When an increase is as substantial as what has been proposed in Congress, it will not dissuade current users of the products but instead push them to the illicit market.”
The proposed menthol ban, Ready Blom said, would result in similar black-market activity. Fortunately, because the Food and Drug Administration must follow a strict rulemaking process, there is time for retailers to get involved.
“FDA announced in May that it will initiate a notice and comment rulemaking in the next year to ban menthol cigarettes, as well as cigars and cigarillos,” said Ready Blom. “As part of the notice and comment rulemaking process, FDA will publish a proposal to ban these items, and then the public will have a time period to file comments before the agency finalizes the rule.” Ready Blom expects to see the FDA’s proposal on menthol sometime in 2022.
The potential nicotine mandate is even further out. While the FDA began considering this policy under the Trump Administration (and continues to do so under Biden), it has not yet issued a notice of proposed rulemaking to do so. Goldman Sachs Analyst Bonnie Herzog noted in a research note that “at a minimum, there is a mandatory one- to two-year delay between issuing a final rule and policy implementation.”
Both Altria and British American Tobacco (parent to Reynolds American Inc.) have expressed concerns about the real-world consequences of lowering nicotine levels.
“(Any FDA action) must be based on science and evidence and must consider the real-world consequences of such actions, including the growth of an illicit market and the impact on hundreds of thousands of jobs,” Altria told Bloomberg. “Many consumers wrongly believe that a cigarette very low in nicotine content is lower in risk than traditional cigarettes, a misconception that poses a major hurdle in determining proposed rulemaking for low nicotine cigarettes,” British American Tobacco told Bloomberg.
What would such a policy look like? It’s likely too early to tell.
“FDA has some authority to reduce nicotine levels,” Ready Blom said. “They clearly can't make nicotine zero, but it’s not clear exactly how far they can go. FDA will have to go through a full notice and comment rulemaking to do it, and it is likely they will face litigation.” With cigarettes remaining such a crucial category to the convenience channel, Ready Blom said NACS will continue to help retailers get involved: There is already a Call to Action where retailers can send a pre-drafted letter to their members of Congress opposing the excise tax increase, and a similar campaign is expected once the FDA releases its menthol ban proposal. “It’s imperative that both legislators and regulators hear from convenience retailers about the impacts of these policies on their businesses,” she said.
The Power of CSX Data
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