E-cigarettes, once considered an odd novelty, are now increasingly becoming part of the societal norm. The huge growth in the electronic cigarette market and E-liquid, however, is causing some investors great concern, particularly those who have purchased some of the $96 billion worth of tobacco bonds currently active in this country.
With an ever-increasing number of U.S. citizens forgoing traditional smoking for nicotine-producing vapers, the state issued bonds are hanging in the balance. Of course, investors had planned for a decrease in tobacco consumption, but their estimates of a two percent decline were modest, at best. The average annual decrease in cigarette usage, since 2000, has been closer to three and a half percent and many fear that this figure is headed on an upward climb in the coming years.
According to the CDC, 18.1% of American adults are smokers. That’s the equivalent of 42.1 million U.S. citizens. Surely, this stunning figure provided reason to believe that tobacco bonds were a safe and wise investment. However, many failed to account for the e-cigarette growth. The ability for smokers to swap out tobacco products for cleaner, more acceptable vapers, has led to a more drastic fall in cigarette consumption. Many tobacco bonds could be in default within just ten years, at this rate.
It makes sense that cigarette smokers would be looking for another alternative. Not only is the ban of public smoking making it increasingly difficult for smokers to get their fix when away from their homes, the Washington Post reports that approximately 500,000 people die in this country, each year, as a result of conventional cigarette use. E-cigs and E-liquids are more widely accepted in public facilities, they do not produce the toxic cloud of smoke that cigarettes do, and they provide a method of weaning oneself off nicotine completely.
Vaporizers are not overwhelming the tobacco market just yet. They still hold only a very small percentage of the customer base, but their $2.2 billion in sales has been enough to earn the attention of tobacco giants. Some believe that e-cigarettes could take more than half of the market by 2024, which has many of the biggest names fighting for a hold on the next best seller.
Not long ago, there was a report issued by Reuters, which suggested the merger of Reynolds American Inc and Lorillard Inc. Both are well known among the smoking communities, as the second and third largest tobacco cigarette manufacturers. However, it was very likely Lorillard’s Blu e-cigs that served as enticement for Reynolds. The vaporizer brand cost Lorillard $135 million just two years ago. However, Reynolds isn’t new to the arena either. They released their Vuse e-cigs recently.
The appeal to the American public is undeniable and these companies know it. ABC News released an informational piece of e-cigarettes a while back, reporting that, among other advantages,
Starter kits usually run between $30 and $100. The estimated cost of replacement cartridges is about $600, compared with the more than $1,000 a year it costs to feed a pack-a-day tobacco cigarette habit, according to the Tobacco Vapor Electronic Cigarette Association. Discount coupons and promotional codes are available online.
Between 2012 and 2013, tobacco companies sold nearly one billion fewer packs of traditional cigarettes. Yet, in that same span of time, e-cigarette sales doubled. This is where the trouble lies for bond investors.
According to the Master Settlement Agreement, from sixteen years ago, tobacco companies agreed to pay forty-six U.S. states annual payments based on national tobacco shipment levels. These funds were meant to recoup some of the costs put forth by the states to pay for education and healthcare expenses related to citizens’ tobacco use.
The majority of the states involved made the decision to sell bonds in advance, in order to collect the funds up front. In return for the immediate funds, they promised annual payments to bond holders. Investors liked the deal, especially given the 6.24% average yield, which was a vast improvement over the 2.9 percent paid on general muni bonds.
Unfortunately, the outlook might have appeared sunny, but in reality, tobacco is proving just as detrimental to investment health as it is to physical wellbeing. Moody’s Investors Service predicts that up to eighty percent of those bonds are doomed to default.
Ready to point fingers as they face great losses, investors are turning on the states that issued the bonds, pointing out the fact that the funds are not being put toward their intended use. Since the MSA was passed, only fourteen and a half percent of the allotted payments have been put toward causes recommended by the CDC. Instead, in the weak economy, several states have chosen to use the funds to boost reserves or to pay down debt.
In order to soften the blow for bond holders, some of the states in questions are releasing general funds to be used toward the annual bond payments. New Jersey was said to have released more than twelve million dollars for this cause. Ohio could pull more than thirty-one million dollars for the same reason.
The future has yet to be seen, but with e-cigarette and e-liquid sales continuing on an upward trend, investors have reason to question to real return potential of tobacco bonds.
