Tobacco.org

• Is the U.S. Cigarette Industry Going Up in Smoke? 

It has been a difficult year so far for the domestic tobacco firms, which have struggled to balance the retail price of cigarettes with the economic trends affecting many of their core customers. We've been concerned for much of the last year that cigarettes were starting to reach price points at which demand could start to falter, so we weren't too surprised to see volumes decline for all of the domestic manufacturers during the first quarter of 2008. The magnitude of the decline, however, when combined with the economic forces we face today and the potential for increased regulation and excise taxes in the year ahead, has led us to lower our near- and long-term expectations for all three of the U.S. cigarette manufacturers-- Philip Morris USA/Altria (NYSE:MO - News), Reynolds American (NYSE:RAI - News), and Lorillard/Carolina Group (NYSE:CG - News).

Domestic tobacco stocks tend to respond to three main drivers: litigation, industry fundamentals, and changes in the political or regulatory environment. Although the litigation environment has improved substantially during the last five years, leading to a dramatic runup in the shares of Altria (up more than 50%), Reynolds American (200%), and Carolina Group (150%), the specter of multi-billion-dollar lawsuits or settlements has not completely gone away. . . .

we've revised our long-term volume growth expectations for the industry from negative 2%-3% per year to annual declines of 3%-4%. With the economy likely in recession and food and fuel expenditures taking up a larger and larger portion of consumer spending, we expect industry volumes to decline at a slightly greater rate in both 2008 and 2009. With only limited pricing power going forward, we now envision a much different sales and profitability environment for the industry than we did even just a few short months ago.

Of the three domestic cigarette producers we cover, we expect Reynolds to be affected the most, as the company has effectively bet the farm on the success of its three top brands

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