Altria to Beat California to the Punch by Raising Cigarette Prices

By Rich Duprey Markets Fool.com

Setting one domino in motion causes the others to fall in line. Altria (NYSE: MO) decided to raise cigarette prices early, which predictably has other tobacco companies following suit in hiking their prices too. But a move by California to increase state excise taxes by $2 per pack was the original domino that set the others tumbling.

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A taxing situation

California voters approved a ballot referendum last November that raised the excise tax on cigarettes -- and, for the first time, products like electronic cigarettes that contain nicotine -- from $0.87 to $2.87 per pack. California is second only to Texas in industry volume by state, with about 8% of the U.S. tobacco market; Wells Fargo analyst Bonnie Herzog had anticipated the excise-tax hike would translate into a per-pack price increase of 8% in the state.

The high cost of cigarettes keeps rising. Image source: Getty Images.

So it shouldn't be a surprise that Altria and the other tobacco companies said they would also raise the price of their cigarettes to offset the impact of the taxes. Altria was first, announcing an increase of $0.08 per pack beginning on March 19, but it was quickly followed by Reynolds American (NYSE: RAI), Imperial Brands' (NASDAQOTH: IMBBY) ITG Brands, and Vector Group's (NYSE: VGR) Liggett Vector division, all of which also raised prices by a similar amount. Two implemented theirs sooner: Reynolds' hike went into effect on March 16 and ITG's on March 17, with Liggett's following March 20.

The only unusual development was the timing of the price hikes. Typically Altria and the others raise prices twice a year, in May and November, but they're beating California to the punch this time as the new, higher excise tax goes into effect on April 1. Following the excise-tax increase enacted in Pennsylvania last August, analysts estimate the combination of the two could reduce industry volumes by about 1% this year.

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By raising their own prices, the tobacco giants can minimize the hit to their profits. Because of the addictive quality of cigarettes, smokers tend to absorb price increases, which is why governments like taxing them; California is hoping to generate as much as $1.4 billion in new revenue from the higher excise tax.

Still a profitable business

Despite decades of declining use, tobacco companies themselves are highly profitable operations. Last year Altria reported that adjusted per-share profits rose 8.2% to $3.03, even though its Philip Morris USA division's volume of domestic cigarette shipments decreased by approximately 2.5%, in line with the industry's decline. Reynolds' profits were up 16% year over year (its volumes were higher from 2015, but that was largely due to adding the Newport brand to its portfolio from the acquisition of Lorillard). Both Imperial and Vector also recorded double-digit profit gains.

Image source: British American Tobacco.

While there is some concern that other states might follow suit, it's notable that similar ballot measures in Colorado, Missouri, and North Dakota all failed. What is more worrisome is the extension of tobacco taxes to non-tobacco products like electronic cigarettes that could kill off the still-growing vaping industry.

A threat to e-cigs

Because e-cigs and vaping devices are reduced-risk products, regulating and taxing them like combustible cigarettes could eventually destroy their allure. While federal action is unlikely in the next few years, individual states could move to restrict or ban flavors, much as was tried with menthol cigarettes a few years ago, or to limit the nicotine content in e-liquids.

It remains to be seen whether the early-spring action on cigarette prices means that the hikes that typically follow later in the year will still do so. Altria and the other companies didn't raise prices after Pennsylvania's tax hike, but Altria announced its November increase a week early -- in fact, immediately after the California ballot initiative passed.

Cigarette usage remains on the decline and tobacco companies themselves are planning on a smoke-free future, but until then they'll rely upon smokers continuing to light up, no matter how expensive the habit gets.

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Rich Duprey has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.