BAT to Miss Vaping Goal as Big Tobacco Faces More Uncertain Era

(Bloomberg) -- British American Tobacco Plc said revenue from smoking alternatives will miss expectations this year as it issued a more pessimistic outlook for the tobacco industry’s new products than rival Philip Morris International Inc.

The maker of Lucky Strikes lopped 10 percent off its target for revenue from electronic and noncombustible cigarettes this year. BAT now forecasts 900 million pounds ($1.2 billion) after it recalled a device in the U.S. and Japanese demand for so-called heat-not-burn tobacco has gone flat. The stock fell as much as 1.3 percent, trading near its lowest level in four years.

So-called heat-not-burn technology like BAT’s Glo is “not a complete substitute for smoking,” Ben Stevens, BAT’s financial director, said in a phone interview. “It’s not going to sweep the world as some of our competitors say it will.”

The contrasting assessments of the prospects for cigarette alternatives underline the industry’s volatile turn. Big tobacco is facing its biggest disruption in years amid a plethora of alternatives to smoking, and cigarette makers are finding they can no longer rely on predictable, steady growth as the new product category faces issues such as recalls and regulatory crackdowns.

BAT shares, which have almost tripled over the past decade, are on track for their first annual decline since 2008.

Uncertain Future

The uncertainty the industry is now facing is self-evident: Even the biggest tobacco companies can’t agree where their future lies. Philip Morris, which is expanding its IQOS heat-not-burn device around the world, has predicted that one day demand for smoking alternatives will be so strong it will stop making traditional cigarettes.

“The long-term investment case at BAT -- and for the industry -- is opaque compared with what we have come to expect from tobacco,” wrote James Edwardes Jones, an analyst at RBC Europe who rates the stock underperform.

BAT’s new target for next-generation nicotine delivery, while lower than before, still represents a doubling of revenue, both in vaping and in heat-not-burn, Stevens said. BAT has forecast the segment to bring in more than 5 billion pounds of revenue by 2022.

That kind of rapid growth has raised concern among regulators that the new products are attracting underage consumers. The U.S. Food and Drug Administration last week sent letters to 21 manufacturers of smoking alternatives, including BAT, demanding more information and threatening to prohibit their devices if they aren’t complying with U.S. rules.

“We’re completely aligned with the FDA,” and BAT has put up obstacles that prevent underage consumers from buying e-cigarettes online, Stevens said. “Young people should not smoke and should not vape.”

Japanese Shift

Japan is the market where heat-not-burn has had the biggest success, and the amount of cigarettes sold there has dropped by about 20 percent over two years. Now, however, it’s getting harder to persuade more traditional consumers to adopt new habits, which include recharging an electronic device that heats up tiny tubes of reconstituted tobacco.

The growth in Japan, which has yet to be reproduced in another market, is attributable to factors that aren’t all present in other countries, Stevens said. Japan prohibits electronic cigarettes with nicotine, so there are fewer alternatives to smoking, plus the country gives a tax advantage to heat-not-burn.

South Korea is probably the market with the next-biggest potential, the financial director said. Heat-not-burn tends to succeed more in places where menthol cigarettes are popular and where smokers feel a bigger sense of consideration for people around them, he added.

While Philip Morris’s main focus is on heat-not-burn, BAT is pursuing a more diversified strategy. BAT is expanding more in oral tobacco and vaping, which it expects to remain more popular in the U.S. and Europe.

The big question is how much the traditional tobacco industry will shrink. BAT still gets 94 percent of its revenue from its combustibles business, and Stevens said that will remain “significant” for a “long time ahead.”

However, as the Japanese case has shown that traditional cigarettes can be at risk, cannibalization has become a bigger issue.

“We remain concerned about the transition of revenue and profit pools from combustibles to next-generation products,” wrote Richard Taylor, an analyst at Morgan Stanley.

To contact the reporter on this story: Thomas Mulier in Geneva at tmulier@bloomberg.net

To contact the editors responsible for this story: Eric Pfanner at epfanner1@bloomberg.net, John J. Edwards III

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