Marketing war brewing between Pall Mall and competitors

The remarkable sales surge of Pall Mall over the past three years has gotten the attention of R.J. Reynolds Tobacco Co.‘s main competitor.

Bonnie Herzog, a Wells Fargo Securities analyst, said in a report last week that the rivalry between Pall Mall and fellow discount brand Marlboro Special Blends — made by Philip Morris USA — has the potential to “turn into a blood bath” in terms of marketing.

Pallmall Nanokings cigarettes

Pall Mall’s market share rose 0.3 percentage point in the past 12 months to 8.6 percent, unchanged from the third quarter. That’s up from a 1.95 percent market share when Reynolds elevated it to a growth brand in 2006.

Pall Mall not only has supplanted Camel as Reynolds’ top brand but also chipped away at Marlboro‘s dominant grip on the top market share.

Because high gasoline prices have left most consumers with less disposable income, analysts said, Pall Mall’s move over Camel could be more than a short-term shift.

Herzog said she formed her prediction after conducting a survey of tobacco industry retail and wholesale trade contacts representing thousands of retail stores.

“The majority of our respondents indicated that promotional activity behind second-tier brands such as Pall Mall, L&M and Marlboro Special Blends has increased,” Herzog said.

“PM USA appears to have stepped up its game with L&M, and promotional spending behind Marlboro Special Blends continues to be aggressive, which could result in Marlboro share starting to stabilize,” Herzog said.

As part of her report, Herzog raised her rating of Altria Group Inc. to “outperform” and lowered Reynolds American Inc.’s rating to “market perform” because of “our concerns that Pall Mall is under siege.”

Herzog said Reynolds will need to expand its promotional support behind Pall Mall, which could put pressure on its margins in the near term.

Camel cigarettes

“Although we believe Pall Mall continues to resonate with value-seeking consumers, the brand is not immune to competitive pressures, and, therefore, we are projecting a deceleration in the brand’s growth,” Herzog said.

David Howard, a Reynolds spokesman, said the company “does not comment on pricing or promotional strategies” as part of its policy.

However, Reynolds reported its overall cigarette market share was down 1.1 percentage points to 27 percent in fiscal year 2011 compared with a year ago. Its cigarette volume was down 7.4 percent for the quarter and 5.1 percent for 2011, compared with an industry decline of 3.5 percent for the year.

The company said at that time the cigarette volume was affected by rivals aggressively promoting brand extension.

Daniel Delen, Reynolds’ chief executive and president, has said for months he thinks Pall Mall “is the right product at the right time.”

Delen said Reynolds “remains very much focused on Camel above all else, but we’re very happy and confident that we can continue the growth on Pall Mall as well.”

“As we go through different economic cycles, they both play an extremely important role within the portfolio,” he said.

Pat Shehan, owner of Tarheel Tobacco in Winston-Salem, said it’s clear the marketing is attracting smokers to Pall Mall, L&M and Marlboro Special Blends over sales of lower-tier cigarettes.

Marlboro Filter Plus cigarettes

“I really believe smokers want a national brand, and the manufacturers are pricing their cartons to put some brands back in their range,” Shehan said.

For example, he said his stores are selling cartons of Pall Mall and L&M at $29.49 and cartons of Winston and Marlboro Special Blends for $32.70.

By comparison, the Tarheel Tobacco stores are selling Camel at $40.27 a carton and Marlboro at $42.70 a carton.

“Customers are telling us they really can’t tell much of a difference between the national discount brands and the national premium brands, so they’re saying, ‘Why spend $10 more?’ ” Shehan said.

He also said more customers are switching to roll-your-own tobacco.

The challenge for Reynolds and Philip Morris, Shehan said, is persuading smokers to go back to their premium brands as the economy recovers and consumers have more disposable income.

Mark Sowers, vice president of K&M Wholesale Co. Inc. of Lexington, said cheaper cigarettes continue “to grab a larger share of the market.”

“Some people are going to smoke their brand no matter its cost as long as it’s available,” Sowers said. He cited as an example female smokers who smoke Virginia Slims at $60 a carton.

Although he doesn’t foresee L&M or Marlboro Special Blends overtaking Marlboro as Philip Morris’ top brand, he expects the brands will take away some market share.