Sweden Meets Its Match in Tobacco
Swedish Match Faces a Raft of Foreign Rivals and Has Little Choice but to Compete at the Low End of the 'Snus' Market
Tobacco is sometimes smokeless, but it can still leave investors burned. Shares of Swedish Match fell 6.2% Tuesday, wiping out all of the year's gains, when the company reported a 10% decline in operating profit for the third quarter. Much of the weakness was in Swedish Match's home market of Sweden, where it generates about 50% of its operating profit. The trouble continues to be a raft of competitors that entered Sweden in the past couple of years to compete in the market for "snus," a moist tobacco product that users place in their mouths to absorb nicotine. The likes of Japan Tobacco, Imperial Tobacco and British American Tobacco have offered their own versions to Swedes at lower prices, taking market share from the incumbent. Indeed, Swedish Match said competition remained intense in the low-price segment during the third quarter. The foreign rivals are unlikely to let up anytime soon. Unlike Swedish Match, large tobacco corporations earn the vast majority of their profits elsewhere. That gives them an incentive to price their products very aggressively so they can build Swedish market share, even if it means sacrificing profit. Gabriela Malczynska of Barclays estimates that nonpremium snus will account for 52% of the Swedish market in 2017, up from 35% in 2012. In turn, Swedish Match has little choice but to compete at the low-end of the snus market. Unfortunately, operating margins in that category are far thinner than in the premium segment. So even if Swedish Match holds on to market share, its margins will probably suffer. One area of potential growth is the budding U.S. snus market, where Swedish Match has yet to make an operating profit but is growing quickly as consumers choose cigarette alternatives. Yet electronic cigarettes, another smokeless-tobacco product, are growing far faster and have financial backing from deep-pocketed tobacco companies such as Lorillard. There is a good chance that smokers will choose electronic cigarettes, which mimic the traditional experience, rather than snus. Even after Tuesday's stock slide, Swedish Match trades at 15.5 times consensus forward earnings, higher than almost any major tobacco company. While Swedish Match's strong brand should serve investors in the long term, now is no time to take it up.