The other “Big Tobacco” companies are also jumping into the e-cig market, with Altria Group Inc (NYSE:MO) just releasing its own e-cig under the brand name MarkTen in an attempt to get into this fast growing market. Reynolds American, Inc. (NYSE:RAI) is planning on launching a revamped version of its e-cig brand VUSE so smokers can get the “perfect puff.” Competition is starting to heat up, so more money will be spent on marketing. This is especially true in the TV space because you can legally advertise e-cigs (unlike traditional cigarettes).
Reynolds American, Inc. (NYSE:RAI) is launching a TV ad campaign to promote its VUSE e-cig and it is starting out in Colorado in September. Lorillard Inc. (NYSE:LO) is countering with a TV commercial staring Jenny McCarthy.
Advertising helps get the product out there and can boost sales in the e-cig market regardless of who is putting out the ad. Spending on TV advertising for e-cigs grew 17.9% in 2012 and is up 71.9% in print advertising in particular . It is hard to tell if e-cigs will ever be able to grow out of a niche market, but only time will tell.
While I have no doubt that the e-cig market will continue to grow, even if it reached $1 billion in annual sales, that pales in comparison to the $100 billion a year traditional-cigarette market. So e-cigs, even with the increased marketing campaigns and distribution, would have to grow enormously to compensate for the drop off in traditional cigarette demand. If cigarette sales keep falling like they have, even e-cig growth won’t be enough to turn these companies’ profits around.
But the huge dividend
The reason why investors own these companies is because of their huge dividends. Altria Group Inc (NYSE:MO) pays out a 5.6% dividend yield, Reynolds American, Inc. (NYSE:RAI) pays a 5.2% yield, and Lorillard Inc. (NYSE:LO) pays a 5.1% yield. These are all twice the average of the S&P 500 yield and very appealing. The problem is how can all of these payouts last when the cigarette industry is on the decline in the U.S.?
In the near term, these companies will keep lobbying against tax increases and will push through price increases to keep profits growing. Ultimately, however, their profits will start falling hard as cigarette sales keep falling and they can no longer push through price increases. At some point, there will be a plateau in U.S. demand, but I don’t want to ride that train downhill to get there. As the market keeps shrinking, margins will be compressed to save market share and the dividends will have to be cut as profits plummet.
Final thoughts
While the dividends look attractive, the long-term prospects of the cigarette industry in the US look bleak. Less and less people are picking up cigarettes and more people are quitting. Everyone knows cigarettes are very unhealthy, and the stigma around them is keeping younger consumers away. You can’t keep paying out large dividends forever when your market is shrinking; eventually they will be cut and shareholders will get burned.
The article Dividends up in Smoke originally appeared on Fool.com is written by Callum Turcan.
Callum Turcan has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned.
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