Despite taxation and regulation, convenience store retailers remain optimistic about this lucrative category, though a potential ban on menthol products is looming.

By John Lofstock, Editor.

In an era in which the sports page sounds like the business page, talk of selling cigarettes inevitably sounds like political rhetoric.

When c-store operators talk cigarettes these days they inevitably end up talking taxation and legislation. And as America struggles to find the proper balance between individual rights and societal responsibility, retailers everywhere are getting squeezed.

But at least there is reason for optimism.

At present, noted Thomas Briant, executive director of the National Association of Tobacco Outlets (NATO), of the 22 states that have proposed cigarette tax increases none has actually enacted one.

“In fact, at this same time last year seven states had already passed a cigarette tax increase,” Briant said. “Right now, eight states have either outright defeated a cigarette tax increase, or it did not pass because the legislature has adjourned for the year.”

In terms of a year-over-year comparison, 2011 is looking much better from a cigarette tax increase standpoint. “The same flows over into other tobacco products—including cigars, smokeless and roll your own—because about the same number of states have tax-increase proposals on those products, but again, none of them have been passed or enacted.

Staying the Course
A lot of that sentiment comes from the November 2010 elections. “There is a real sense that legislators are not going to raise taxes—even taxes on cigarettes and tobacco products—in this economy and in this environment,” Briant said. “The voters said, ‘Stop taxation, stop the spending,’ and we see that actually now playing out in state legislatures, with none at this point enacting any kind of cigarette or OTP tax.”

Although that in no way guarantees that none will get passed, those legislatures that do will almost certainly be fewer in number than what was seen in 2010. “It’s very good news,” Briant added, “and retailers have been very responsive in contacting their legislators. So overall it’s very good news for the industry, no question.”

Briant also pointed out that no further smoking restrictions have been passed by states, whether restricting the smoking of cigarettes, cigars or pipes.

In a rare win for tobacco retailers the Second Circuit Court of Appeals ruled that New York State could collect cigarette taxes on purchases made by non-Native Americans from Native American retailers. This move would help to level the playing field for c-store owners in New York.

The New York Tax Department’s collection regulations require wholesalers to add the state’s $4.35 per-pack tax on each cigarette pack sold to Native American retailers. “We will now begin the implementation phase as we move to collect these taxes,” said Gov. Andrew Cuomo. “I have always said that taxes on cigarettes sold to non-tribal members must be collected because this is revenue rightly owed to the state, and with this decision, my administration will move to do so expeditiously.”

It took nearly 20 years for the state to acquiesce. “We think it’s a victory for taxpayers and the fundamental principle of fairness,” said James Calvin, executive director of the New York Association of Convenience Stores, which has battled the state legislature on this issue for two decades.

Help From Indiana
Andrea Myers, executive vice president of marketing for Kocolene Marketing LLC, the Seymour, Ind.-based operator of 12 Fast Max c-stores and 19 Smokers Host tobacco stores, said legislators in Indiana—where 28 of her chain’s stores operate—recently helped ease some of the margin pressure that had been building.

On May 11, a 2% rise in the state-mandated pricing minimum went into effect—welcomed relief from manufacturer programs that had been pushing prices downward. As for the federal and state legislative assaults on cigarettes in general, Myers added, “It’s a tough battle to be profitable anymore, one you have to really stay on top of in order to fight for your business.”

Whether it’s federal, state or local taxation issues there is a constant battle to keep tobacco margins in line. “With the FDA involved and record keeping requirements what they are, cigarettes cost more to carry now due to inventory and additional work that needs to be done. That all affects profitability,” said Frank Davoli, director of sales and marketing for South Bend, Ind.-based Richmond-Master Distributors Inc., both a supplier and retailer that owns and operates 10 Bonkers c-stores and 37 Low Bob’s Discount Tobacco stores.

Like Myers, Davoli decried manufacturer programs that dictate retail pricing and welcomed Indiana’s recent raising of the mark-up from 8% to 10%. For the foreseeable future, Davoli concluded, “the battle will continue.”

Debating Menthol
While trying to protect margins, retailers are also concerned over the future of menthol cigarettes. In early May, Louis Sullivan, former secretary of Health and Human Services under President George H. W. Bush, and Joseph Califano Jr., former secretary of Health, Education and Welfare under President Jimmy Carter, penned an op-ed piece in The Washington Post in which they called upon the FDA to ban menthol cigarettes.

Expanding the Family Smoking Prevention and Tobacco Control Act of 2009 (which prohibits cigarettes
flavored with any spice, herb, fruit or other flavor) to include menthol, the pair argued, “would do more to save lives, reduce health-care costs and curb the tobacco industry’s exploitation of children and minority teens than to ban menthol flavoring in cigarettes.”

Lyle Beckwith, the senior vice president of government relations for NACS, said that banning menthol cigarettes risks giving rise to an entire industry of unregulated cigarette products.

“It is simply not reasonable to expect that the menthol market, which accounts for roughly 30% of cigarette sales today, will vanish overnight or could be phased out over time,” Beckwith said. “Combined with the relative ease of obtaining menthol flavorings, black market manufacturers will sprout up very quickly.”

While the production, distribution, sale and end-use of contraband tobacco has existed for years, what has changed recently, authorities said, is that criminal enterprises have expanded their reach and sophistication. “As tobacco taxes have been hiked to raise revenue and deter smoking, illegal sales have become increasingly lucrative, leading to more widespread and sophisticated criminal enterprises,” Beckwith said.

It is more important than ever that retailers join together to beat down any efforts toward eliminating or restricting menthol sales.

“They just keep trying to drive people away from (cigarettes),” said Butch Fulton, merchandise manager for Plaid Pantries Inc. in Beaverton, Ore. “I guess the only thing we can hope for is that it drives a lot of the big guys out of the cigarettes business. It’s so expensive to be in that the large-format stores don’t want to mess with it because it’s such a small piece of their volume. Instead, they’re giving it to the little guys.”

Fulton, whose chain operates 104 stores, said his cigarette volume has continued to be “really strong. We’re doing well with the Philip Morris family and especially whatever fourth-tier we bring on. The fourth tier does real well for us.”
In an economy like this, that’s hardly a surprise, Fulton noted. “When you’re paying $4 a gallon for gasoline you’ve got to cut money wherever you can. I think the gas prices have definitely hurt our inside sales of everything.”

For the year ahead, Fulton predicted the same inevitable outcome that NACS warned of. “The government keeps trying to force people to quit smoking and as that happens, more and more people will turn to the black market to buy products,” he said. “The government will eventually realize that the decrease in cigarette tax revenue isn’t coming from people quitting. It’s because customers are spending on the black market.”