E-Cigarettes: An Emergent Threat To Big Tobacco?

The cigarette sector is well known for its cash generation abilities, moderate valuations, and generous dividends. Having survived years of lawsuits and a somewhat diminished demand, the sector still promises some earnings growth and stability.

Although production, consumption and even exports in the US have been on a clear downward path as shown below (source: CDC, "Cigarette Production, Exports, and Domestic Consumption—United States, 1990–2007"), the companies have been able to adapt through price increases, cost cuts, and conquering new external markets.
The sector presents homogenous valuation in terms of Price/Earnings and Dividends, although with somewhat different growth rates, making for a wide dispersion of Price/Earnings/Growth (PEG), falling between the 1.4 awarded to Philip Morris International (PM) and the 3.0 that Reynolds American (RAI) gets.

The sector’s high ROEs are both a function of its stable, highly profitable, nature, and the fact that these companies have repurchased a lot of shares which greatly impacted their book value (this is particularly evident in Philip Morris International).

The threat

Along the years, big tobacco has survived many threats, the two largest being the endless lawsuits due to the health impact cigarettes have, and the lower overall consumption (some of it also coming from the health hazard being much more widely known now).

However, there’s a new threat emerging presently: e-cigarettes and the associated “vaping”. With these new cigarettes, the smoker doesn’t actually smoke – he inhales a vapor mix that includes both a flavor, and nicotine.