Despite whatever Patrick Lagreid might think, I think I did a B+ job on the Ten Questions for 2016 and as such, I feel more than qualified to make some more bold predictions. This is the seventh consecutive year where I’ve asked 10 questions facing the cigar industry for the upcoming year, though the reality is this could probably better be labeled: 10 predictions for 2017.
In case this is the first year you’ve read the Ten Questions, it goes like this: I ask what I believe are the 10 biggest questions for the cigar industry in 2017, I make predictions on each one of them and 363 or so days from now, Patrick Lagreid will grade my predictions.
And with that, let’s begin with seven FDA-inspired questions and a trio of bonus material.
1. Are FDA regulations suspended or overturned in 2017?
On Aug. 8, the U.S. Food & Drug Administration (FDA) began regulating premium cigars. While many of the regulations, including warning labels and product testing and approval, are still not fully underway, there are a few restrictions already in place, notably:
- No new products can be introduced unless they were on the market as of Aug. 8, 2016
- A ban on free samples
- Retailers must ask for identification for anyone under the age of 26
- FDA has begun collecting user fees from manufacturers and importers
There are a few different ways the rules could be stopped, whether temporary or completely.
One is through Congress, an effort that has been attempted numerous times, even before the regulations were proposed in 2014. The Congressional bills have focused on overturning part of the law that gives FDA authority to regulate premium cigars. While the standalone bills have gained hundreds of co-sponsors through recent sessions of Congress, the hope of Congress limiting FDA authority has been through adding language to bills that fund FDA that would prevent the agency from regulating premium cigars. So far, these efforts have had marginal success, but ultimately failed.
The next most obvious place would be through a lawsuit. So far, there have been two lawsuits filed by premium cigar interests, including a joint lawsuit from the industry’s three largest trade groups. That lawsuit will get underway in mid-2017 at the earliest, but it seems unlikely the cigar industry could get a favorable ruling in such a short time. What could happen would be an injunction on all or part of the law that grants a temporary solution.
On Jan. 20, Donald Trump will become the 45th president of the United States. Trump has broadly stated that he would like to overturn many federal regulations on businesses and other members of the Republican party have specified FDA’s regulation of cigars and e-cigarettes as one of the regulations they would like to see overturned. Because FDA is an executive agency, Trump does have authority over such rules.
Finally, FDA itself could limit the rules. I think this is the most likely scenario as FDA has already begun to delay some of the earlier deadlines regarding the regulations. It stands to reason that if the initial parts have been delayed, the larger and more complicated parts might also be delayed. There’s also the Department of Health and Human Services (HHS), which directly oversees FDA, which will likely have a new director that has been cigar-friendly in the past. The rumored appointee to head FDA itself is also expected to be very anti-regulation.
Prediction: FDA will continue to delay some parts of the deeming regulations, though likely not the larger parts as those deadlines don’t begin until 2018. Congress goes nowhere, Trump does nothing and the lawsuit is too early to have any effect in 2017.
2. Do CRA & IPCPR merge?
A few months ago, there was chatter amongst some of the higher-ups at both organizations that a merger was on the horizon for the cigar industry’s two most prominent lobbying groups: Cigar Rights of America (CRA) and the International Premium Cigar & Pipe Retailers’ Association (IPCPR).
In some ways, it would make sense; the two groups are fighting the same fight, and along with the Cigar Association of America (CAA) are involved in a lawsuit against the U.S. Food & Drug Administration (FDA). On an ever more increasing basis, the differences between the two groups are becoming more and more minutia.
CRA has been billed as a consumer organization, similar to the NRA. Yet, for all intents and purposes, it is probably more a manufacturers association. Its 10-member board has eight manufacturers, one retailer and one “consumer.” One of its board members—Davidoff’s Jim Young—is also a board member at IPCPR and its lone retailer, Gary Pesh, served as IPCPR board president just two years ago.
On the other side, the IPCPR has historically been a retailers’ association, though it too is becoming increasingly reliant on manufacturers, both implicitly and explicitly. The annual IPCPR Convention & Trade Show is a huge cash cow for the organization, something that is funded largely by the manufacturers who exhibit. If it needed a large influx of cash, it seems more likely that it would come from manufacturers more than retailers.
I think the concept of separate manufacturer, retailer and consumer organizations has its benefits, but it would take a radical makeover of all three organizations and how they operate in the status quo to achieve three organizations that weren’t primary funded by manufacturers.
Combining the two organizations, which likely have very little in the way of large philosophical differences, would do what any merger would: reduce overhead and streamline operations. Yet, the smaller differences might keep the merger from taking place. While it’s not pretty, I also think ego and trust will play a big role. The CRA was largely created after the CAA sided with larger cigar manufacturers, many of whom had little to no premium cigar business, in the negotiations over SCHIP. I think many of the CRA’s leadership and large donors prefer to be in control of their own destiny, something that would be diminished in the event of a merger.
Prediction: There will not be a merger between the two groups in 2017.
3. How many new stores will STG (Cigars International) open in 2017?
On the retail front, 2016 has been the year of Imperial/Casa de Montecristo/JR. The year before that was Davidoff. Now the question is will 2017 be the year for Scandinavian Tobacco Group (STG), which owns Cigars International and General Cigar Co., to make its big push into the same arena?
With the acquisition of Serious Cigars and planned stores in Austin and Nashville, Imperial Brands, through its Casa de Montecristo and JR Cigar stores, will have a total of 16 stores in the United States. Its largest competitor, Cigars International, has just three shops as well as Club Macanudo in New York, which STG owns.
How does STG respond to Imperial’s expansion? Is it new stores, likely under a name that is not Cigars International? Is it acquisition? A combination of both? Does they look more like Cigars International or does it try to go more high-end like Club Macanudo? Imperial decided to do all of the above and I suspect STG will follow a similar path. So the question then becomes, how aggressive will STG be?
Prediction: Five new/newly-acquired stores from STG by the end of 2017 with plans for more.
4. How many new cigars will there be in 2017?
In the weeks leading up to this past Aug. 8, a host of manufacturers rushed thousands of new cigars onto the market so that they would meet the deadline set by the upcoming FDA regulations. In short, any cigar that debuted on Aug. 8 or after would have to get FDA pre-approval before it could be sold in the U.S. Any cigar sold before Aug. 8 would have up to three years before a manufacturer has to submit it for approval and the products can remain on the market until FDA rejects the application.
The result was thousands of phantom brands: cigars that were introduced in very limited fashion solely to meet the Aug. 8 deadline with the intention of having these brands available for introduction later on. There are murmurs that companies like Alec Bradley and Rocky Patel have thousands of new SKUs between the two of them. Regardless of whether that’s true, there are a lot of phantom brands ready for their more formal debuts.
While phantom brands aren’t subject to FDA pre-approval, they are subject to FDA approval and as such, it seems likely that most companies will want to try to sell them in the next year. If a company were to wait until say March 2018 to begin selling a certain phantom brand, it would only have until August of that year before it would have to submit for substantial equivalence approval, if it opted against that, the line could be sold until Aug. 8, 2019, at which point the product would have to be pulled from the market or apply for the much costlier premarket tobacco product application (PMTA), a process that involves hundreds of hours and is estimated to cost upwards of $1 million.
The cost of substantial equivalence is still rather unknown, but the median estimate for lab testing seems to be around $20,000 per cigar. It’s unclear if this could be reduced across multiple vitolas, but if the cost of lab testing cannot be reduced, it would mean companies would be forced to spend millions if not tens of millions of dollars for compliance on 1,000 SKUs of phantom brands, products that are for all intents and purposes not on the market.
As I’ve written before, cigar manufacturers must be careful passing down these costs to retailers and consumers. Neither group wants to pay for products they don’t sell and buy—and none of them are going to be happy paying for the applications of hundreds of lines that aren’t even for sale yet.
Prediction: 1,500 “new” SKUs for 2017, roughly similar to 2015.
5. Which premium cigar company is the first to be penalized by FDA?
And—to what extent. I think there will be warnings issued to both manufacturers and retailers in 2017, though that’s really an extension of the status quo. But, warnings are not punishments and the first punishment will very much set the tone for what companies do going forward.
Because of the amount of remaining questions regarding FDA regulations, companies are interpreting the gray areas quite differently. Until FDA punishes someone for an improper interpretation, it is very much the wild west, but the first punishment—no matter how punitive it actually is—will be a shockwave.
In many ways, it’s the next major step from FDA and while no one wants to see it happen, everyone wants to see how it happens.
Prediction: The first violation will be for a domestic manufacturer, likely a retail store that rolls its own cigars that is completely oblivious to the regulations. We will have to wait until 2018 to see the first nationally distributed cigar company paying fines.
6. Will FDA regulations lead to more mergers and acquisitions of cigar companies and brands?
Ever since the threat of FDA regulation, there has been a belief that it would lead to an increased amount of mergers and acquisitions. Since FDA regulations were announced, there have only been two noted cases of companies being sold: Oliva, a deal that was underway well before FDA regulations were announced, and more recently Sosa being acquired by A.J. Fernández, something that Sosa seemed to somewhat anticipate. Yesterday, there was a merger involving two smaller companies: Black Patch and T.L. Johnson.
Yet, there was another big acquisition: the aforementioned acquisition of Serious Cigars by Imperial/Tabacalera USA/Casa de Montecristo.
Officials from larger companies have told me they haven’t been inundated with companies looking to sell themselves, something that could change as the remaining pieces of FDA regulation become clearer, though it’s unclear how much clarity 2017 will provide.
And yet, my hunch is it’s not going to change much.
Prediction: Let’s put the over/under at six manufacturer/brand acquisitions for 2017. Almost as many retail stores get acquired by multi-national corporations in 2017.
7. Is there any company that doesn’t raise prices between August 2016 and the end of 2017?
Most of the biggest names in the cigar industry have already announced price increases because of FDA regulations. Lawyers, lab testing, user fees and more man hours to handle FDA compliance all cost money—money that will ultimately come from consumers. It does merit mentioning that for the most part, cigar manufacturers have raised prices nearly every year for the last five years as the cost of manufacturing has gone up.
Now the question is—is there anyone of noticeable size that doesn’t raise prices because of FDA?
Perdomo famously decided not to raise prices after the implementation of SCHIP, which added a 40.26 cent fee to many cigars on the market. The company made the decision a key aspect of its marketing and it certainly has played a big part in its growth and success over the last seven years. But just a couple of weeks ago Perdomo announced it would be raising prices, in part because of FDA.
If even the seemingly most staunch absorber of government-induced fees can’t stomach it, what is to think anyone else can?
There’s one company that comes to mind as someone that might hold off, if only for a year: Oliva. J. Cortès, which purchased Oliva earlier this year, would create a lot of goodwill as the one manufacturer that didn’t raise prices, even if it’s only temporary.
Of note, the other logical choice would be Arturo Fuente, a company where the vast majority of the company’s products are likely to meet the Feb. 15, 2007 grandfather date that would exempt them from costly product testing, however, a source told me that the company will be raising prices in 2017.
Prediction: Many small companies won’t raise prices, but Oliva will be the only major manufacturer to absorb FDA costs in 2017.
8. When does the big sell off take place?
Large catalog retailers like Cigars International and JR Cigar are sitting on a lot of cigars they’d like to get rid of. This isn’t simply an inventory problem or a general desire to make money; the companies are taking steps to ensure they are no longer selling products that aren’t in compliance with FDA regulations. This means there are likely millions of cigars at just a handful of the bigger retailers that will need to be sold before August 2019.
As of now, there’s no penalty for selling a product that is not in compliance come Aug. 8, 2019. However, FDA could issue a legal directive that would ban the retailers from selling specific products that are no longer in compliance. If they did this with every cigar that wasn’t in compliance on the market, those millions of cigars could become close to $10 million in losses. As such, the bigger retailers are doing more than just limiting inventory, with some going so far as asking manufacturers to sign contracts stating that they will apply for FDA compliance for all brands that the retailer decides to carry.
It’s a lot of cigars to sell and while catalog deals have been aggressive of late, the big sell off still looms. Even if it’s spread over the course of six months, the idea that millions of cigars are placed on the market at extreme discounts will have implications far greater than just consumers. Depending on how steep the discounts are, some smaller stores could end up buying cigars from the catalog and online retailers since the clearance prices offered may be better than the wholesale prices the brick and mortars get.
This also doesn’t take into account whatever inventory manufacturers themselves discount because they don’t intend on applying for approval for and any companies dumping inventory as they exit the business.
Prediction: 2017 is going to be a great year for consumers when it comes to cigar deals. Catalogs try to sell the majority of the non-compliant inventory in 2017.
9. How many new Nicaraguan factories open outside Estelí in 2017?
For many years, Nicaragua’s cigar industry has been one that is extremely unique. Almost all the cigars were made in the city of Estelí, which would be a small American town by most geographic standards. There’s been a few exceptions, notably Mombacho Cigars S.A., which operates in Grenada. But now things are really starting to change.
AGANORSA is a partner in the new SABSA factory in Jalapa; A.J. Fernández has announced the company will be taking over the old San Rafael factory in Ocotál; Davidoff is said to be working on operations in Condega, which could include a rolling operation. I don’t know why so many have gone outside of Estelí, but I’m guessing that rising land and labor costs have made it cheaper to produce cigars in other areas of the country.
If that’s not the case and the issue is that Estelí has either run out of space or labor, the implications could be much bigger.
Prediction: There won’t be many more new factories from established companies outside of Estelí. Over/under is set at 1.5 new factories outside of Estelí for 2017.
10. Will global warming become a concern of the collective cigar industry?
Talk to tobacco growers around the world and they will all tell you the same thing: growing is not like it used to be. The historical growing seasons are changing and the unpredictably of the weather is becoming an annual occurrence and problem. Yes, the weather is always somewhat unpredictable, but it’s now becoming chaotic.
At the 2016 Puro Sabor, Nicaragua’s cigar festival, the event’s press conference was very pointed on the matter with most stating that late rains forced the country’s farmers to plant much later than the historical start date. A month later at the Dominican Republic’s Procigar festival, Nirka Reyes stated that estimates were the Dominican Republic could have 20 percent less tobacco than the previous crop because of a lack of rain.
And then there is Cuba.
In 2014, Cuba’s famed Pinar del Río growing region lost 12 percent of the crop because of late rain. The following crop was described as better, but suffered from a “critical lack of rain.” This past crop was described as a “disaster” with farmers taking the drastic step of replanting crops in early 2016 because of an extreme amount of rain in January, a month where Cuba is normally dry.
The American cigar industry is largely conservative when it comes to politics, which means it collectively falls somewhere between being less than the most receptive audience to the concept of global warming and flat out denying it. And yet, the entire industry relies on nature to produce the products it sells. Those involved in the growing of tobacco care about the environment; not just the rain and the temperature, but also conservation, sustainability and pollution. However, that concern isn’t felt in the domestic industry, at least not yet.
Prediction: Global warming enters the fray for some in the industry, but only on the peripheral. The “big issues” for the industry remain FDA and taxes, not a big three of FDA, taxes and global warming.