Taxation and legislation could present a rocky road for cigar manufacturers.

By Erin Rigik, Associate Editor.

Thanks to new flavors and price promotions, cigar sales at convenience stores remain as strong as ever.

The cigar category at U.S. convenience stores totaled $2.38 billion for the 52 weeks ended April 21, 2013, up 3.73%, according to SymphonyIRI Convenience All Scan data. Unit sales, meanwhile totaled 1.46%, down 1.3%. The average price of a cigar was also down slightly for the 52 weeks, SymphonyIRI reported. The price per unit averaged  $1.63 for the same period, a drop of $0.04.    

Cigars made up 32.1% of the other tobacco products (OTP) category syndicated sales in 2012, a drop of 1.2% year-over-year, according to NACS State of the Industry (SOI) data. Cigars saw monthly sales of $2,109 on average at c-stores, with monthly gross profit dollars of $728 on a gross profit margin of 34.5%.

Trending Now
The e-cigarette trend sweeping across the tobacco segment is causing cigar retailers and manufacturers to take note.
“Only one member company of ours does an e-cigar and that is Swisher International, and even that is just being test marketed now,” said Craig Williamson, vice president of the Cigar Association of America (CAA). “I think the market is shifting. All companies, all manufacturers have been looking at the e-category for some time. A lot of that what happens there will have to do with what the FDA plans on doing.”

The e-cigarette category in 2009 was $39 million, in 2012 it was $500 million and 2013 it’s expected to be $1 billion, according to Wells Fargo. “Compare that to the fact that premium cigars had retail sales of $500 million in 2012 and that shows you how these e-products have taken off,” Williamson said.
But even as the cigar industry monitors the success and regulations around the e-category, traditional cigars continue to stay strong thanks to product innovation and value. 

On the premium side, customers are gravitating toward larger cigars. “Ten years ago it was smaller ring gage cigars that were shorter in length, and now customers like larger cigars,” Williamson said. 

Meanwhile, on the domestic mass market side that makes up the bulk of the c-store business, foil packaging continues to drive sales of cigars. “Foil packaging has taken off in the past 4-5 years, simply because you can put 1-5, cigars in it, and it keeps the product fresher, so it’s always fresh,” Williamson added. 

Discount Smoke Shops, which has 50 stores in Missouri, Illinois and South Dakota, drives sales of domestic cigars by featuring a promotion on a different domestic cigar line every month.

“We sell a lot of flavors on the domestic cigars, but flavors are not requested as much in the premium,” said Ray Calderon, director of marketing and merchandising for the Springfield, Mo.-based tobacco chain. “In domestic cigars there are a lot of new flavors coming out, and pineapple has been very big over the last 3-4 months on the domestic side.”

But Williamson pointed out that flavors are not a new phenomenon. “Flavorings have been around for a long, long time,” he said. “We spoke to the FDA recently, because they are concerned about kids using flavorings. But flavorings have to be used in all cigars because it’s a type of tobacco, and you wouldn’t be able to smoke a cigar without flavorings. The first advertising done with flavorings was 1874 with strawberry, and 1890 was peach; so I’m trying to point out that a lot of these flavors aren’t new—they’ve been around for a long time.”

Legislative Front
The Obama Administration’s proposed budget includes a 94 cents per pack increase in the federal cigarette tax rate and an increase in all other tobacco tax rates, including on cigars, by a similar proportion. If enacted into law by Congress, these tobacco tax increases would go into effect on Jan. 1, 2014.
“The president’s plan would devastate our industry,” Williamson noted. 

The other bill causing concern is Senate Bill 826. Introduced by a number of senators, the proposal aims to equalize the federal tax on OTP with the cigarette tax rate. If enacted, little cigars would be taxed at $1.95 per pack of little cigars weighing up to 4.5 pounds per thousand, up from the $1.01 per pack tax rate currently in play.

“The industry will also face users fees from the FDA once they take jurisdiction over cigars and pipes,” Williamson said.
The FDA noted in its regulatory agenda for the year that it planned to expand federal oversight of tobacco products under the Family Smoking Prevention and Tobacco Control Act. Currently the tobacco industry pays an amount of $700 million a year, divided by categories and manufacturers regulated by the FDA.

“So for cigar manufacturers, our portion will equal what our market share is. You have a lot of small manufacturers that are having a tough time now making the payments for State Children’s Health Insurance Program (SCHIP) and to ask them to do anything more, or to ask the consumer to pay anything more, will be very hard,” Williamson said.

But even as cigar taxes could prove burdensome to manufacturers, David Bishop, managing partner at Balvor LLC, said it might not be so drastic for retailers.

Taxing Issues
Federal tax increases affect the players—retailers, wholesalers and manufacturers—in different ways.

“What we saw with SCHIP was a concern broadly held by all parties involved that an increase would be negative to the business. In hindsight, it turned out to offer somewhat of a stimulative effect for retailers and in effect wholesalers. The federal excise tax is paid by the manufacturers and the product is then sold to wholesalers, who in turn have a markup. Based on that, their percentage is then off a larger base of the per unit penny profit increase. In turn, retailers, who use more of a margin-based pricing, were able to realize stronger penny profits on a per unit basis,” Bishop said. “Obviously, if they sell fewer units that doesn’t really work for them, but what we found is a federal excise tax increase for retailers is equalized across all states, so the disadvantage is kind of mitigated in that.”

State taxes can prove more burdensome to retailers because they can inspire customers to traverse state lines for cheaper products, Bishop added.

Another looming piece of legislation impacting cigars is the Marketplace Fairness Act, also known as the Internet Tax Bill. From a cigar manufacturer perspective, this is “a huge problem,” said Williamson. “Basically, all the mail order firms would have to pay taxes. However, with cigar sales, 50% of our premium sales are done by mail. In Wyoming for instance, you may be four hours away from the closest store that sells cigars. There are so many different shapes and sizes of cigars that no one cigar shop is going to carry every cigar at the same time. We just had about 47,000 letters going to 25 members on the Hill, and we’re going to do another round to another 25 members to defeat this bill.”

The bill was voted out of the Senate and now remains in the House where it has been referred to the Judiciary Committee, where Chairman Robert Goodlatte (R-Va.) suggested it move through the regular procedure in the House. At presstime, no date has been set for a hearing.

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