Wall Street Tobacco Industry Update · 2019-02-15 · Wall Street Tobacco Industry Update NATO Education Seminar –February 11, 2019 Bonnie Herzog, Senior Analyst Managing Director

Wall Street Tobacco Industry UpdateNATO Education Seminar – February 11, 2019

Bonnie Herzog, Senior AnalystManaging DirectorBeverage, Household & Personal Care, Tobacco & C-Stores ResearchWells Fargo Securities, [email protected]

All estimates/forecasts are as of 2/8/19 unless otherwise stated.

Please see page 28 for rating definitions, important disclosures and required analyst certifications.

Wells Fargo Securities, LLC does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of the report and investors should consider this report as only a single factor in making their investment decision.

Bonnie Herzog - Wells Fargo Securities, LLC | Tobacco, Beverage & C-Store Sectors 1

Discussion TopicsØ Overview of Current Tobacco Industry Trends

o Combustible Cig Vol Deceleration Accelerates

o JUUL Leads E-Cigs/Vapor Renaissance

o FDA Cracks Down on E-Cig Youth Access While Advocating “Continuum of Risk” Approach & New Nicotine Strategy

• Removes Certain E-Cig Flavors From C-Store Channel

• Encourages Long-Term Shift in Adult Cig Consumption to RRPs

• Premarket Tobacco Product Application (PMTA) Deadline for Marketing Newly Regulated Non-Combustible Products is August 8, 2022

Ø Notable Industry Developments

o Altria Takes 35% Equity Stake in JUUL, Exits Own E-Cig Biz

o Total U.S. Nicotine Pool Set To Grow as New Users, RRP Dual-Usage, & Per Caps Increase

o Expect Consumption of RRPs to Exceed Combustibles in Next Decade

Bonnie Herzog - Wells Fargo Securities, LLC | Tobacco, Beverage & C-Store Sectors

Combustible Cig Volume Deceleration Accelerates

2

Ø Combustible Cig Volumes Decelerate Below Historical Average Declines

Ø E-Vapor Resurgence & State Excise Tax Increases Impact Cig Industry Vol

Ø Net Price Realization, However, Remains Robust, Up ~5%

U.S. Combustible Cig Volume Growth

-4.6%-5.2%Hist.Avg.

-3.2%

-10%

-8%

-6%

-4%

-2%

0%

2%

4% %GrowthY/Y

Source : Company Reports and Wells Fargo Securities, LLC estimates


JUUL Leads E-Cig Resurgence

E-Cig $ Share PerformanceThru Nielsen 4-wk period ended 1/26

Ø JUUL has re-ignited U.S. e-vapor category growth, accounting for nearly all of the category’s growth to date

Ø JUUL represents >30% share of the overall e-vapor category, across open/closed systems and all trade classes

Ø U.S. e-vapor volume is expected to grow at a +15-20% CAGR thru 2023

E-Cigs’ Share of Total Nicotine Pool is Still Small, But Growing

Source for both graphs: Nielsen; Wells Fargo Securities, LLC

Nielsen All Channel Scanner Data Thru 1/26/19

4/13Vuserecall

0

10

20

30

40

50

60

70

80

D F A J A O N J MM J S O D F A J A O D J MM J S N D F A J A S N J

2014 2015 2016 2017 2018 2019

JUUL

BAT

MO

Fontem(Blu)

Logic

NJOY

(%) 4-wk retailshare performanceChewingTob(Smokeless)

8.4%

Cigars4.5%

E-Cigs4.7%

87.7%

Cigs(RHS)82.5%

79.0%

80.0%

81.0%

82.0%

83.0%

84.0%

85.0%

86.0%

87.0%

88.0%

89.0%

0%

1%

2%

3%

4%

5%

6%

7%

8%

9%

D F A J A O N J M M J S N D F A J A O D J M M J A O D

2015 2016 2017 2018

TobaccoCategoriesas%ofTotalU.S.TobaccoMkt


U.S. Adult Tobacco Consumer In Good Shape

4

Ø Gas Prices Remain Relatively Low & Consumer Confidence Is At Highest Level Since 2001

Ø Supports Strong U.S. Adult Tobacco Consumer

Ø Favorable Macro Trends Favor Premium Brands

U.S. Pump Prices NormalizingAvg Price Per Gallon of Regular Gas

U.S. Consumer ConfidenceUp Generally, But Unevenly Spread

Source: U.S. Energy Information Administration (EIA), Wells Fargo Securities, LLC

Source: FactSet, The Conference Board, Wells Fargo Securities, LLC

$2.42

$2.72$2.47 $2.62

Hist.avg.

$1.00$1.20$1.40$1.60$1.80$2.00$2.20$2.40$2.60$2.80$3.00

J MM J S N J MM J S N J MM J S N J MM J S N J MM J S N J MM J S N

2015 2016 2017 2018 2019E 2020E

U.S.AvgPricePerGallonofRegularGradeGas Annualaverages

$2.42

$2.15


Cig Vols Strongly Correlated to Gas Price Trends

5

Sources: U.S. Energy Information Administration (EIA) for gas prices; Nielsen


U.S. Adult Tobacco Consumer In Good Shape

6

Ø "Customer counts in general are decreasing as we are seeing in cigarettes as well fortunately overall sales are up--so average purchase has increased in Q4, we started to see cigarette units go negative.“

Ø "2018 proved to be a good year in Tobacco. Customers tend to purchase more traditional cigs than we saw in RYO, and foot traffic was up.“

Ø “With the warmer weather we experienced, traffic/customers were slightly up over the past 4-8 weeks."

U.S. Adult Tobacco Consumer Responding Well to Loyalty Programs

Overall Traffic Trends Largely Unchanged But Warmer Weather & Promos Helped

Source: 4Q18 “Tobacco Talk” Survey Source: 4Q18 “Tobacco Talk” Survey

21%23%

12%17%18%

24%

33%27%

47%

60%62%

48%

61%55%

44%54%

32%

16%

26%35%

21%21%22%

19%

asof1Q17

asof2Q17

asof3Q17

asof4Q17

asof1Q18

asof2Q18

asof3Q18

asof4Q18

asof1Q17

asof2Q17

asof3Q17

asof4Q17

asof1Q18

asof2Q18

asof3Q18

asof4Q18

asof1Q17

asof2Q17

asof3Q17

asof4Q17

asof1Q18

asof2Q18

asof3Q18

asof4Q18

Stronger Same Weaker

WhatdoyouthinkaboutthestateoftheU.S.adulttobaccoconsumer?

13%

27%25%

14%12%

36%32%

25%

50%45%

39%41%

53%

28%

39%43%

37%

27%

36%

45%

34%36%29%31%

asof1Q17

asof2Q17

asof3Q17

asof4Q17

asof1Q18

asof2Q18

asof3Q18

asof4Q18

asof1Q17

asof2Q17

asof3Q17

asof4Q17

asof1Q18

asof2Q18

asof3Q18

asof4Q18

asof1Q17

asof2Q17

asof3Q17

asof4Q17

asof1Q18

asof2Q18

asof3Q18

asof4Q18

Stronger Same Weaker

Whatareyouseeingintermsofoveralltraffictrends inyourstores?


But Traffic Pressure Continues…..

7

Ø JUUL & Dual-Use Contributing to Pressure, but Cig Mfr Pricing, Strong Loyalty Programs & Promos Are Expected to Be Key Offsets

Ø “More alternatives to combustibles + higher cigarette prices = slower sales”

Ø “We are not sure that gas prices will stay low as projected, which could result in customers trading down”

Ø “Gen Z is not smoking, retails are too high (pricing power is dead), and people are moving to vape, just as the FDA moves to suppress vape”

Retailers Expect Slightly More Cig Vol Pressure in 2019

~30% of Retailers Attribute Cig Vol Softness to E-Cig Conversions & Dual Use

Source for both graphs: 4Q18 & Ad Hoc “Tobacco Talk” Surveys published in Feb 2019 and Nov 2018, respectively; Wells Fargo Securities, LLC estimates

0.4%0.6% 0.6%

0.1%

-1.1%-1.4% -1.4% -1.2%

-1.6% -1.6% -1.5% -1.6%-1.9% -1.8%

4Q15 1Q16 2Q16 3Q16 4Q16 1Q17 2Q17 3Q17 4Q17 1Q18 2Q18 3Q18 3Q18 4Q18

2016EOutlook

2017EOutlook

2018EOutlook

2019EOutlook

ForwardYearGrowthExpectationsProvidedbyRetailersEachQuarter

(UpcomingYearvsPriorYear)

6.0%

6.0%

8.0%

10.0%

10.0%

14.0%

18.0%

28.0%

Downtrading

DeclineinConsumption/ConsumerTrends

PriceofGas

Unsure/Other

Weather

Market/CategoryPressures

Pricing

SmokerShift(E-Cigs/Dualuse)


Next Cig List Price Increase Expected Late March

Expected Dateof Next Cig List Price Increase

Ø $0.09/Pk Cig List Price Increase (+2-3%) Expected in Late March

o To Be Led By PM USA (as usual)

o Over 55% of Retailers/Wholesalers Predict $0.09-$0.10 Per Pack

Ø Bottom line – Reflects Industry’s Confidence/Ability To Price Through Vol Weakness

Expected Amount (per pack)Of Next Manufacturer List Price Increase

Source for both graphs: “Tobacco Talk” Survey; Wells Fargo Securities, LLC estimates

“Tobacco Talk” Survey – February 2019

3% 2% 2% 2%

6% 5%

17% 17%

25%

8%

3% 2%5%

0%3% 3%

Janu

ary

4-Feb

11-Feb

18-Feb

25-Feb

4-Mar

11-M

ar

18-M

ar

25-M

ar

1-Ap

r

8-Ap

r

15-Apr

22-Apr

29-Apr

May

June

January February March April May June

Weekof

March Total:64%

5%2%

30%

13%

43%

8%

$0.04-$0.06 $0.07 $0.08 $0.09 $0.10 >$0.10

ExpectedIncreaseperPack

Avg: $0.09/pack


History of Cig List Price Increases

Source: Company data; Wells Fargo Securities, LLC estimates

$0.06$0.07

$0.06$0.07 $0.07 $0.07 $0.07

$0.08$0.08 $0.10$0.09

$0.10$0.09

1.6%1.2% 1.2%

1.9% 1.9%

2.6%2.0%

2.7% 2.5% 2.5%3.0% 2.8%

2.5% 2.3%1.9% 1.9%

2.4%

6.6%

5.7%

6.5%

5.5%

2.4% 2.3% 2.4%

Avg%Incr(Y/Y)2.9%

0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

6.0%

7.0%

($0.01)

$0.01

$0.03

$0.05

$0.07

$0.09

$0.11

$0.13

Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1

2013 2014 2015 2016 2017 2018 2019E

PerPackCigListPxIncr($) RetailPrice/PackY/Y%Increase(RHS)

4/1/17- CA$2/pkexcisetax

effective ??


Cig Price Gaps Relatively Steady

10

Absolute & Relative Price Gap Between Premium (Marlboro) & Deep Discount Cigarettes (Q/Q)

Ø Absolute Price Gap Widening to a record high $1.64/pk but….

Ø Relative Price Gap Relatively Stable at 31%

Ø Retailers See Vape As “Big Winner” Given Lower Price Points Relative to Cigs

Ø Altria Notes Continued Churn Within Deep Discount From Branded to Non-Branded

Source for graphs: Company reports; Wells Fargo Securities, LLC


Key Brand Trends in Q4


Marlboro & Deep Discount Share Improving

Ø “Marlboro volume started to stabilize and return.”

Ø “As the category shrinks, the most price sensitive people in the economy are making up a larger share of the category."

Source: 4Q18 “Tobacco Talk” survey

Improved41%

20% 20%14%

Improved63%

35%

Worsened41%

Worsened47%

Worsened63%

12%

18%

33%27%

18%12%

6% 6% 6% 6%14%

MAR L B ORO N EW P OR T C AMEL P A L L MAL L D EEP D I S C/ 4THT I E R

Improved Worsened Unchanged Unsure


PM USA: Marlboro Share Pressure Receding

Ø The Marlboro Brand Franchise

o Among the Strongest & Most Recognizable Consumer Brands Worldwide, In Our View

o Strong Loyalty Program & Effective Promo Strategy Making Positive Impact

o We Expect Marlboro to Continue to Outperform the Overall Cig Industry

Source for both graphs: Company data and Wells Fargo Securities, LLC

Marlboro U.S. Market Share Performance Marlboro Showing Signs of Stabilization

Hist.Avg.42.0%

20184Q43.0%

34.0%

36.0%

38.0%

40.0%

42.0%

44.0%

46.0%

1Q 3Q 1Q 3Q 1Q 3Q 1Q 3Q 1Q 3Q 1Q 3Q 1Q 3Q 1Q 3Q 1Q 3Q 1Q 3Q 1Q 3Q 1Q 3Q 1Q 3Q 1Q 3Q 1Q 3Q 1Q 3Q

2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018

10bp

20bp

10bp

0bp

30bp30bp

10bp

20bp

(20bp)

(40bp)

(20bp)

(30bp)

(10bp)

(30bp)

(50bp)

(60bp)

(50bp)

(30bp)

(10bp) (10bp)

(70)(60)(50)(40)(30)(20)(10)-10203040

42.0%

42.5%

43.0%

43.5%

44.0%

44.5%

1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q

2014 2015 2016 2017 2018

PptChangeY/Y(RHS) MarlboroRetailMktShare(%)

$2/pkCAexcisetaxincreaseeffective4/1/17


RJR & ITG Also Seeing Some Improvement in Nielsen Data

14

BAT/RJ ReynoldsNielsen All-Channel Scanner Data Thru 1/26

Latest Nielsen 4-Wk Scanner Data:

Ø Volume Pressure Easing Led By Newport at -2.6% for 4-wks ended 1/26 (vs -7.4% for 12-wks)

Ø Camel Vol Also Improving at -5.1% (vs -6.6% for 12-wks), Albeit Still Weak

Ø Natural American Spirit Growth Continues With Vol Increasing +2.7% (vs +1.0% for 12-wks)

Ø ITG Performance Remains Alarming With Winston Vol Down -15.3%, Albeit Better Than In Recent Periods

Source for graphs: Nielsen; Wells Fargo Securities, LLC

-12%-10%-8%-6%-4%-2%0%2%4%6%8%

-12%-10%-8%-6%-4%-2%0%2%4%6%8%

D F A J A O N J MM J S O D F A J A O N J MM J S O D F A J A O D J MM J S N D F A J A S N J

2012 2013 2014 2015 2016 2017 2018

Volume Pricing SalesGrowth

RAIfollowsMOonearlyl istpriceincreaseinmid-March

-20%

-15%

-10%

-5%

0%

5%

10%

-20%

-15%

-10%

-5%

0%

5%

10%

D F A J A O N J MM J S O D F A J A O N J MM J S O D F A J A O D J MM J S N D F A J A S N J

2012 2013 2014 2015 2016 2017 2018

Volume Pricing SalesGrowth

Imperial TobaccoNielsen All-Channel Scanner Data Thru 1/26


View on FDA’s Recent Decisions


FDA’s New “Continuum of Risk” Is Positive For U.S. Vapor

16

Ø Embraces “Continuum of Risk” (i.e., Relative Risk) vs Abstinence

Ø Encourages Innovation At the Lower, Less Harmful End of the Continuum

Ø Extends Deadline for Submission of Deeming Reg Applications for Newly Regulated Tobacco Products in Market as of 8/6/16

o Deadline for Newly Regulated Combustible Products (Cigars, Pipe Tobacco & Hookah Tobacco): August 8, 2021

o Deadline for Newly Regulated Non-Combustible Products (e-cigs or ENDS): August 8, 2022

Ø Bottom Line - We Think The FDA’s New Approach Will Encourage Consumers To Shift More Rapidly to Vapor/RRPs


FDA Announces E-Cig Action Plan

17

Ø On 11/15, the FDA Announced a 5-Pt Action Plan To Address the E-Cig Youth “Epidemic”

1. C-store restrictions – Require certain e-cig flavors to be sold in age-restricted locations in c-stores

2. Online sale restrictions – Required heightened age verification process for e-cigs sold online

3. Flavored cigar ban – FDA intends to propose a product standard to ban flavors in all cigars

4. Remove e-cigs that explicitly appeal to kids – e.g., candy flavors, cartoon labels

5. Menthol ban in cigs/cigars – Accelerate the proposed rulemaking process to ban menthol in all combustible tobacco products

Ø Bottom Line – The FDA Must Carefully Navigate How to Reduce Youth Uptake While Accelerating Adult Smoker Conversion to Non-Combustible Alternative Products Like E-Cigs/Vapor/Heat-Not-Burn (HNB)


Retailers Broadly Disagree W/FDA’s E-Cig Action

18

FDA’s Action to Restrict Certain E-Cig Flavors Viewed As “Too Extreme”

“Tobacco Talk” Survey Takeaways:

Ø “The FDA is not going to reduce the consumption of underage smoking, teenagers will get the product one way or another”

Ø “Moving the legal age and focusing on removing 'youth targeted' marketing would have a similar, effective, impact”

Ø “Consumers will go elsewhere to purchase and will likely buy other products while they are there, reducing traffic and total sales”

Source for graphs: Tobacco Talk Survey, Nov 2018 Wells Fargo Securities, LLC

While E-Cigs Are Still A Tiny Contributor to Overall C-Store Sales, Retailers Anticipate Neg Impact As Consumers Go Elsewhere

Agree9%

Disagree/Unfair/TooExtreme

77%

DrivenbyBigTobacco

9%

NoOpinion5%

Negligible25%

Positive12%

BasketSize8%

StoreTraffic31%

ConsumerBehavior

4%Broad-based20%

Negative63%


Retailers Seeing Some Negative Impact on E-Cig Volumes

19

Ø “Initially sales fell way off but as people realized that whatever the FDA did would take months, if not years, than things normalized somewhat.”

Ø “The real answer is not yet…legislation won't necessarily slow down the category -just cause a shift of balance to vape and age-restricted outlets and away from c-stores.”

Source: 4Q18 “Tobacco Talk” Survey

Yes,alot6%

Yes,some42%

Notmuch20%

Notatall28%

Unsure4%


FDA Announces Comprehensive Nicotine Strategy

20

Ø On 7/28, the FDA Announced a Comprehensive Regulatory Plan To Lower Cigarette Nicotine Levels & Reduce Addiction to Combustible Cigs

o Places Nicotine At the Center of the FDA’s Regulatory Approach

o Seeks to Lower Combustible Cig Nicotine Levels to “Render Cigs Minimally or Non-Addictive”

o Embraces (Finally!) “Continuum of Risk” Approach (vs Abstinence)

o Encourages Industry Innovation Especially In E-cigs/Vapor/RRPs

o Extends the Premarket Tobacco Product Application (PMTA) Deadlines For Marketing Newly Regulated Non-Combustible Products to August 8, 2022

o Allows Marketing to Continue After the New PMTA Submission Deadline As Long As The Application Remains Under Review (vs 1 year limit previously)

Ø Bottom Line – We See This As A Positive Step Forward For the Industry & Public Health, & Expect It To Encourage A Faster Shift In Consumption to RRPs


FavorableImpact10.1%

UnfavorableImpact50.7%

NoImpact26.1%

Unsure13.0%

Yes,morefavorable67.7%

Nochange26.5%

Unsure5.9%

Retailers View of FDA’s Lower Nicotine Strategy

21

FDA Nicotine Strategy Broadly Expected to Be Negative For Combustible Cig Sales


Ø >50% of Retailers Expect the FDA’s New Strategy Could Adversely ImpactCombustible Cig Consumptiono “A De-Facto Ban On Cigarettes”

o “It Will Create A Black Market”

Ø However, >67% of Retailers See A Favorable Shift In FDA’s Stance In Favor of RRPsØ Our View: New FDA Approach Is L.T. Industry Positive As With RRPs:

o (1) Consumers Presumably Live Longer; (2) Lower Risk Profile Encourages More RRP Usage; (3) RRPs Could Merit More Favorable Tax Treatment; (4) Smoking Restrictions Potentially Relaxed for RRPs

Source for graphs: Tobacco Talk Survey 8/17/17 - Wells Fargo Securities, LLC

FDA Nicotine Strategy Signals FavorableShift in Agency’s Stance Twd RRPs


How Big Of A Risk Would A Potential Menthol Ban Be?

22

To Date, Menthol Banned or Restricted in At Least 5 Jurisdictions:

o San Francisco, Chicago, Berkeley, NYC, & Minneapolis


Ø A Ban in More Cities Would Be Negative for the Category

o “That will just be horrible... People will freak out. I mean…Newport!”

o “It would impact the market and sites greatly, especially in urban markets.”

Ø However, Retailers Also Recognize Consumers Would Also Seek Other Means

o “It will drive some shoppers to go to another city to buy products and hurt retailers in the city where the ban occurs. There will be some that will finally quit.”

o “It would send consumers to other markets.”

o “Initially it will be impactful but as time goes on I feel the consumer will adapt.”

Our View:

Ø More Headline Risk Than Real Impact, In Our View

Ø Absent a Comprehensive Ban at the Federal Level, We Expect Some Smoker Attrition & Volume Pressure, But Ultimately a Manageable Risk

Note: Comments taken from our 2Q17 “Tobacco Talk” Retailer Survey.


Sizing Vapor & The Total Nicotine Pool


Vapor In Context – Still “Early Days”

24

Ø U.S. Is Largest Market & Most Lucrative Opportunityo 50% of U.S. adult smokers have tried or expressed interest in Vaporo Continued innovation is critical in our view (taste, quality, convenience & harm reduction)

Ø We Estimate E-Cigs Are <10% of the Total U.S. Nicotine Pool Today, Going to ~30% By 2025

Ø We Estimate the Total U.S. Nicotine Pool is ~$100B in Retail Sales Today, Going to ~$115B by ‘25

Cigarettes Continue to Dominatethe U.S. Tobacco Landscape

Source for both graphs: Nielsen; Wells Fargo Securities, LLC estimates

By 2025, However, We See the LandscapeShifting Significantly Toward Vapor

$0

$20

$40

$60

$80

$100

D M J S N F M A N J A J O D M J A N '20 '23

2015 2016 2017 2018 Estimates

E-cig/vapor

Cigars

ChewingTobacco

Cigarettes

E-cigsas%oftotalnicotinepool~7%in2018to~30% by2025E

($bn)

Cigarettes82%

ChewingTobacco

8%

Cigars5%

E-cig/vapor5%

~$100Bretailsales52-wksended 1/26/19


2019E U.S. Vapor Market Size – $9.0B in Retail Sales Vapor & RRP retail sales in the U.S. will likely eclipse $10B by 2020

Source: Nielsen C-Store Database, Wells Fargo Securities, LLC estimates. *Other Retail channels include tobacco-only outlets and other e-cig retail locations.

25

YearEnd2019ETotalE-Cig/VaporMarket

Size – $9.0B

E-Cigarettes$6.4B

C-Store,Food,DrugandMassRetailChannels

$4.4B

OnlineandOtherRetailChannels

$2.0B

Online$1.2B

Other$800M*

Vapors/Tanks/Mods&PersonalVaporizers

$2.6B

OnlineandOther

Retail

Channels

$550M

VapeShops$1.7B

C-Store,Food,DrugandMassRetail

Channels

$350M


E-Cig $ Share PerformanceThru Nielsen 4-wk period ended 1/26

E-Cigs Contributing More Retail $ Sales Than Cigs Are Losing

Source for both graphs: Nielsen; Wells Fargo Securities, LLC

Nielsen All Channel Scanner Data Thru 1/26

4/13Vuserecall

0

10

20

30

40

50

60

70

80

D F A J A O N J MM J S O D F A J A O D J MM J S N D F A J A S N J

2014 2015 2016 2017 2018 2019

JUUL

BAT

MO

Fontem(Blu)

Logic

NJOY

(%) 4-wk retailshare performance

We See the Nicotine Volume/Profit Pool Growing

Ø As E-Cig/Vapor Product Quality Rises & Competition Improves, Category Volume Growth Should Accelerate

Ø FDA’s New “Continuum of Risk” Strategy Should Support Further Growth

Ø JUUL Remains Market Leader By Wide Margin But There’s Ample Room For Multiple Winners, In Our View

Ø Bottom Line – The FDA’s Harm Reduction Approach to Tobacco Should Drive Stronger RRP Innovation To Support Long-Term, Sustainable Growth


JUUL Bringing in New Users Driving Growth of Nic Pool

Ø “There are many new users, and I believe JUUL has pulled share from all the categories listed above."


9.2% 9.8% 9.8%12.1% 12.1%

13.2%14.9%

4Q1819.0%

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%

Logic Newport OtherCigBrands

OtherE-cigBrands

Marlboro MarkTen Vuse NewUsers

SourceofJUUL'sMarketShare

3Q18 4Q18


Retailers View Altria’s Decision to Acquire a Stake in JUUL Favorably

Ø “Altria has a better relationship with the FDA.“

Ø “I think it is a positive move for Altria, if the FDA behaves but I think they paid too much for it.”

Ø “I believe this was a smart move as Mark-Ten did not sell very well so now they have a 35% stake in the #1 vapor company.”


Neutral23.1%

Negative13.5%

VeryNegative3.8%

Unsure5.8%

VeryPositive21.2%

Positive32.7%

Positive53.8%


We See JUUL & iQOS* As the Strongest Likely Beneficiaries

29

Ø JUUL Has Single-Handily Reaccelerated the U.S. E-Vapor Category

Ø JUUL’s Volume Increased +600% in 2018 to Over $450M Refill Kit Pods, Contributing to Over $1B in Net Revenues

Ø While Not Yet Approved For Sale in the U.S., the Success of iQOS in Several Int’l Markets Bodes Well for its Potential in the U.S.

Ø iQOS Could be Approved for Commercialization in the U.S. Any Day Now

Ø We Estimate that iQOS Could Accelerate MO’s Revenue and Profit Growth and Drive Significant Incremental Value

We Believe JUUL & iQOS Could Represent >30% of the U.S. E-Vapor Mkt by 2025

Note(*): Assumes FDA approval of iQOS for commercialization. Source for both images: Nielsen; Wells Fargo Securities, LLC estimates

As the Mkt Expands/Matures, Their Mkt Shares May Moderate, But Topline Momentum Should Continue

0.1% 3.7%6.5% 8.9% 10.7% 11.9% 12.8%

38.7% 36.5% 34.8% 32.0% 27.1% 23.1% 19.9%

61.2% 59.8% 58.7% 59.1% 62.2% 65.0% 67.3%

'19 '20 '21 '22 '23 '24 '25

Estimates

Est$ShareofU.S.E-Cig/VaporMarket2019-2025E

iQOS

JUUL

Othere-cigs/vapor

$5.5B $6.9B $8.5B $10.7B$13.9B

$17.9B$22.6B

$3.5B$4.2B

$5.0B$5.8B

$6.1B

$6.4B

$6.7B

$0.0B$0.4B $0.9B

$1.6B

$2.4B

$3.3B

$4.3B

'19 '20 '21 '22 '23 '24 '25

Estimates

iQOS

JUUL

Othere-cigs/vapor


iQOS’ Strong Int’l Track Record Bodes Well For Its Future in the U.S.

30

Ø iQOS’s Share of the Cig/HNB Nicotine Pool is Growing in Every Int’l Market Where it Competes

Ø iQOS Conversion Rates Remain Incredibly High at ~70% - The Highest of Any HNB or E-Cig Product Out There

Ø PM & MO Remain Enthusiastic & Committed to Commercializing iQOS in the U.S. When Approved

“HNB” – stands for Heat Not Burn technology. Source for both images: PMI 2016 Investor Day presentation and Wells Fargo Securities, LLC

iQOS’ User Base Is Impressive & GrowingMost Adult Smokers Who Try iQOS Tend to Stick With it


Retailers’ View on iQOS Hasn’t Changed Given Altria/JUUL

Ø “I think iQOS is a different proposition that needs to be conveyed through social media as the closest thing traditional smokes without the negative connotations. If they can create the same buzz JUUL did it will be hot.”


No82.6%

No5.3%

No37.5%

Yes17.4%

Yes94.7%

Yes62.5%

0.0%

15.0%

30.0%

45.0%

60.0%

75.0%

90.0%

105.0%

HasyouroutlookforiQOSchangedgivenAltria'sminoritystakeinJUUL?

DoyoustillplantocarryiQOS?

IfyouplantocarryiQOS,willyougiveAltriaincrementalspace?

Retailers'ViewoniQOSinLightofAltria'sStakeinJUUL


U.S. Opportunity – FDA Review & Decision Timeline Guides

Note: “PMTA” stands for Premarket Tobacco Application, which would grants the right to commercialize iQOS in the U.S.; “MRTP” stands for Modified Risk Tobacco Product application, which would grant the right to market iQOS with a reduced risk health claim. Source for chart: FDA; Wells Fargo Securities, LLC

Ø In a Nutshell:

o PMTA approval would allow iQOS to be commercialized in the U.S. without a health claim

o MRTP approval would allow iQOS to be marketed in the U.S. with a modified-risk health claim

Ø Our Expectation:

o Commercialization in the U.S. this year

o Health claim approval in the U.S. this year, and possibly in conjunction with PMTA approval

FDA Review Timeline For iQOS ReviewImportant Dates Related to the FDA's Review of PM's PMTA & MRTP Applications for iQOS

D J F M A M J J A S O N D J F M A M J J A

2016 2017 2018

MRTP*

PMTA* 3/31/17PMTAfiled

9/27/17PMTAreview"clock"ends

12/5/16MRTPfiled

5/24/17MRTPreview

begins

12/12/17MRTPCommentPeriodends

5/19/18MRTPreview"clock"ends


RRP Competition – “The Future Is Smoke Free”

33

British American Tobacco’s Next-Gen Platform

Japan Tobacco’s Tobacco Vapor ProductLaunching Ploom TECH+ & Ploom S in 2019

Source for images: British American Tobacco PLC, Japan Tobacco Inc, Reynolds American, Inc,, Wells Fargo Securities, LLC

Imperial Brands Is Prioritizing mybluIMB to Invest an Incremental GBP100M in 1H19


What’s Ahead:Global Industry Consolidation?


Key Themes in 2019

Ø Heightened Degree of “Unknowns”

o FDA E-Cig Flavor Crackdown

o Impact of JUUL on Cig Volume Cannibalization (esp for Altria)

o Timing of FDA PMTA/MRTP Approvals & Commercialization of iQOS

Ø Need For Scale/Innovation

o Need For Scale/Innovation May Spur Industry Consolidation and/or Equity/Strategic Partnerships

o RRPs Remain a Key Catalyst

o Profit Opportunity Maintains Attractiveness of the U.S. Market

Ø Continued Deceleration of Combustible Cig Volumes

Ø Industry Pivots Towards Reduced-Risk Product Development

35


PM/MO Combo – We View iQOS/JUUL As Catalyst For Reunification

Ø We Believe FDA’s New Nicotine Strategy Supports Rationale for Deal

Ø iQOS Is Win-Win for Both Philip Morris & Altria Group, In Our View

Ø iQOS Worth More to PM By Owning MO

o PM Captures Full Margin of iQOS

o Accelerates Growth in U.S. Given Full Control Over Sales/Distribution

o Access to MO’s Strong FCF to Catapult Growth of iQOS Globally, In Our View

Ø U.S. Market Is Attractive “Call Option,” In Our View

o Diversification Benefits

o U.S. Is The 2nd Most Lucrative Cig Market in the World

Ø JUUL Needs An International Partner with Infrastructure & Distribution Capabilities + Know How, In Our View

Ø At Minimum - Global Consolidation May Force PM’s Hand

36Note: PM/MO combo, as speculated in a recent Bloomberg article without comment from either management team


Disclosures


Disclosures


Disclosures

SECURITIES: NOT FDIC-INSURED/NOT BANK-GUARANTEED/MAY LOSE VALUE

Documents

Wall Street Tobacco Industry Update · 2019-02-15 · Wall Street Tobacco Industry Update NATO Education Seminar –February 11, 2019 Bonnie Herzog, Senior Analyst Managing Director