E-liquids Claiming Larger Market Share: Cigarette Bonds Head for Default

There is a downward trend within a portion of the investment market that has some celebrating, while other nervously cling to dreams of proper payout.  Outstanding tobacco bonds are looking more than a little volatile as smokers drop their bad habit in record numbers.  Many are suggesting that the growth of the e-liquids market is partially at fault.

How Tobacco Bonds Work

In 1998, the tobacco companies and state government agencies finally saw eye-to-eye, creating the Master Settlement Agreement.  This is now, informally, referred to as the MSA and has resulted in sixteen years of payments made from tobacco companies to forty-six U.S. states.  These payments are not fixed, but rather vary depending on the tobacco shipments annually.  The states also receive a cut depending on their respective populations.

In order to get that money faster, many governments arranged the sale of bonds with appealing rates of return.  The investors willing to put up sums upfront were rewarded with annual paybacks, as the tobacco funds arrived. Trouble arose when the tobacco shipments declines and the payments coming in did as well.

Rapid Growth in E-cig Market

Though the government did expect a slight decline in tobacco usage over time, the drop has been nearly twice what was predicted.  Many people feel that the soaring success of vaporizers and e liquid flavors is the cause of the more drastic drop in tobacco usage.  The ability to get the nicotine in a similar fashion, but without the toxins and within public establishments is a definite draw for many smokers.

Though the sales remain miniscule when compared to those of traditional cigarettes, there were 2.2 billion dollars’ worth of e-cigarettes and paraphernalia last year.  Some analysts believe that this niche could claim more than half of the total market within ten years.

Reuters was among the first to report the possible merger between two tobacco giants, Reynolds American Inc and Lorillard Inc.  What’s the attraction for Reynolds?  Many believe that the deal has much to do with Lorillard’s ownership of Blu E-cigarettes.  Lorilallard bought the leading e-cig brand for $135 million a couple of years ago.

Faster Decline in Tobacco Usage Than Expected

Unfortunately for investors, while many are making positive health choices by giving up their bad habits, the bonds are headed for default.  The majority are expected to reach that point within the next decade. Though projections were expecting a two- or even a three percent drop in consumption, the annual decline has been closer to 3.5 percent on average.  Last year, the drop was 4.9 percent, the highest level of decline since the excise tax was passed in 2009.

In the past, the analysts blamed the banning of smoking in public facilities and the excise taxes for declined consumption, but the rapid decrease suggests that other factors are at play.

Anti-Smoking Ads Certainly part of the decline could be blamed on government agencies’ efforts to spread the word about the dangers of smoking.  The television ads of recent years are rather explicit in their attempts to showcase the true disfigurement that can occur after years of smoking.  Among those is this video, issued by the CDC.

Growing Vaporizer Trend The drop of nearly five percent last year can be, in part, attributed to the growing popularity of e-liquids. In 2013, United States citizens bought nearly a billion fewer cigarettes than the year before, yet sales of e-cigarettes doubled in that same time.  By current estimates, cigarette sales could decrease by nearly seventy percent by 2024, while e-cig sales are expected to reach over five million units by that date.

States Getting Themselves into a Bind

The states were not truly acting irresponsibly, but at the same time, many investors will be feeling a bit uneasy about now.  Even more frustrating for millions is the fact that the states have not done with the money as they had proposed.  The entire purpose for the payments was to help cover some of the expense attributed to the use of tobacco, such as medical expenses.  However, of the one hundred billion paid out thus far, less than fifteen percent has been used for such reasons.

Now states are forced to seek funds from elsewhere as tobacco payments come up short of what is owed to investors.  New Jersey has already withdraw $12.5 million and it is expected that Ohio will pull more than twice that from reserves.

What This Means for Bond Holders

The big attraction to the tobacco bonds was the high rate of return promised.  According to the Standard and Poor’s Index, they matured at 6.24% as compared to the 2.9% earned on general muni bonds.

However, Moody’s is now suggesting that as many as eighty percent of them are headed for default.  Should the decline in tobacco consumption reach rates of six or seven percent in the coming years, the defaults could occur much sooner.  The first cases could be as soon as 2019.

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