Electronic cigarettes – "e-cigs" – are lighting up growth in the otherwise declining tobacco industry. Not to be left out, Hollywood is jumping on the trend. And, there may be a way for investors to get in on it, too.
When bold-faced celebrities take to something, they go all out. That's in part why e-cigs are finding their way into gossip columns these days. Lindsay Lohan and Leonardo DiCaprio, for example, are often photographed with an e-cig on their lips. Robert Pattinson was seen puffing on them after his breakup with Kristen Stewart. Romantic comedy staple Katherine Heigl smoked one on-air during a late-night TV talk show interview. Rolling Stone Ron Wood is a fan and even Charlie Sheen tried dabbling in the e-cig business with his own brand, NicoSheen.
(Read: On the Call: Altria Group CEO Barrington)
But one player is right now on top: Lorillard. The 253 year-old tobacco company controls nearly half of the young market. But, is it the stock to play in a hot market or is it the whole thing just all smoke but no fire?
According to a recent report by Wells Fargo analyst Bonnie Herzog, the e-cig market is roughly between $5 billion and $6 billion in sales, with the United States accounting for $2 billion by year's end. According to Herzog's survey of tobacco retail contacts representing more than 40,000 American convenience stores, annual growth for e-cigs in the third quarter of 2013 were about 30% higher than last year. E-cig sales in the US are expected to hit $10 billion by 2017.
Not surprisingly, cigarette manufacturers are looking to e-cigs as their salvation from declining traditional tobacco sales. Conventional cigarettes sales are expected to decline every year by nearly 7% for the next ten years. Meanwhile, e-cig dollars sales are expected to increase by more than 34% per year on average for the next decade. That means the $28.7 billion in tobacco sales this year are forecasted to shrink o $14.3 billion in 2023. E-cigs are expected to be $27.2 billion ten years from now.
While operating profit margins are lower than conventional cigarettes today (19.5% for e-cigs versus 43% for conventional cigarettes), that's expected to change by 2019, when e-cigs are projected to have operating profit margins of nearly 55% compared to forecasted profit margins of 54% for conventional cigarettes that year. For retailers, e-cigs already give them 50% higher margins than conventional sales.
(Read: On the Call: Reynolds American CEO Daniel Delen)
So, while e-cigs are smaller and less profitable right now for manufacturers, they are expected to take over and be even more profitable than conventional cigarettes in the next few years. And big tobacco is taking action on this.
The largest e-cig player right now is relatively one of the smaller of the big players in conventional cigarettes. Lorillard acquired e-cig company Blu Ecigs for $135 million in April 2012. According to Lorillard, the "blu" brand has 49% of the e-cig market share. Lorillard also acquired Britain's Skycig for $49 million earlier in the month. Close behind blu in market share is privately held NJOY, which received $75 million in funding this summer from investors including Sean Parker (the man behind Napster and Facebook) and PayPal founder Peter Thiel.
Of course, the other tobacco companies are looking to jump in this market as big as they can. Phillip Morris spends nearly a quarter of a billion dollars a year on research and development in "next-gen products". And, industry giant Altria launched its e-cig brand, MarkTen, back in June.
With that in mind, is Lorillard the stock to buy to get into the e-cig market?
CNBC contributor Zachary Karabell, president of River Twice Research, says jumping into a stock because it's a fad isn't the greatest idea in general. "Quirky retail niche stocks can do incredibly well, but they can also be fads that then collapse a lot more quickly than you can get out of the trade," warns Karabell. "For every SodaStream, which is a niche product, there is a Crocs, which equally was."
That said, he does believe that the e-cig market will grow. However, it also may face some regulation, he says, but not to the same extent as traditional cigarettes.
Talking Numbers contributor Richard Ross, Global Technical Strategist at Auerbach Grayson, thinks the technicals for Lorillard are bearish in the short term.
"While the concept of inhaling vaporized liquid nicotine sounds like something out of 'Breaking Bad', the charts are actually breaking out," says Ross. The stock is up 20% in the last two months, Ross points out, "but I wouldn't chase it here".
"Short-term, I'm a seller or I'm on the sidelines," says Ross. "Longer-term, I'd look to get involved on a pullback."
To see the rest of Karabell's fundamental analysis and Ross' technical analysis on Lorillard, watch the video above.
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