blogimageOur research analysts have covered the tobacco sector for decades, applying our stock-specific, ESG-integrated approach to identify suitable investments for our clients. Many tobacco stocks have delivered consistently strong cash flows, attractive dividends and share-price appreciation over the period.

However, with cigarette prices rising as a result of increasing taxes imposed on the industry, and amid a growing desire for non-harmful nicotine alternatives, tobacco companies have faced a considerable challenge to retain their existing customer base and keep their brands relevant in an era of down-trading in particular.

Key to overcoming this challenge has been innovation. The industry has been very active in responding to the changing regulatory environment and evolving consumer demand. There are two key strands to innovation in the tobacco sector that we would like to share with you.

The first is within the more traditional ‘combustible’ products. Just as with many other types of products within the consumer goods area, innovation in tobacco has been focused on adding exciting and original features – something different the consumer is willing to pay a premium for (akin to the concept of ‘all-in-one’ shower gels/moisturisers or dishwasher tablets).

One brand has sought to create a premium product by developing a firmer filter which feels more solid to the smoker and conveys the impression of a higher-quality product.

Some have added ‘stay-fresh’ wrapping, which promises to keep cigarettes fresher for longer, while others have introduced menthol capsules into cigarette filters, which allow the smoker to control the amount of menthol which is released as they inhale. We have also seen some brands tap into a trend which has flourished in the food industry, with so-called ‘natural’, ‘additive-free’ and even ‘organic’ cigarettes.

In a challenging sector, obtaining consumer insight is increasingly becoming a key skill for companies looking to gain a competitive edge. Communicating about these new products in an industry which is largely banned from advertising can be a struggle, so we look for companies with well-established research and development functions, with the ability and experience to roll out their new offerings globally.

So it seems the combustibles area of the tobacco industry isn’t likely to go up in a puff of smoke any time soon. Nevertheless, as the regulatory environment becomes tougher and governments are increasingly forced to raise the tax burden on tobacco in search of revenues, combustibles could face further pressure, which may lead firms to look elsewhere for growth and profitability.

Next week, we’ll write about this second key aspect of innovation in the tobacco sector, one which poses a clear challenge to the companies which operate within the area: can they provide a successful way for consumers to enjoy nicotine in a manner that isn’t harmful to them?

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