Could electronic cigarettes prove a serious threat to tobacco companies?

Analysts at Canaccord Genuity seem to think so, and have downgraded their recommendations on British American Tobacco and Imperial Tobacco as a consequence. Although the e-cigarette market is likely to grow gradually, they believe a decline in tobacco could come more quickly than expected. Canaccord's Eddy Hargreaves and Alicia Forry said:

We think electronic cigarettes will prove to be the most significant development in the history of the organised Tobacco industry, stretching back some 200 years. We expect consumers worldwide to migrate from tobacco smoking to e-cigarettes at an accelerating rate through 2020.

We estimate the e-cigarette market will grow from $2bn in 2012 to $3bn in 2013 (tobacco is approximately $700bn). In the longer term, the total combined market will shrink at a more rapid rate than most investors envisage as e-cigarettes wean smokers off tobacco, but do not attract new users into the overall category. Winners and losers will emerge, but are hard to predict at this relatively early stage in e-cigarettes' development, and there will be margin pressure in the short term across the board as companies race for share. This new uncertainty, and the faster long-term decline of tobacco which we predict, should cause investors to reassess their holdings in the sector. Our modelling suggests that tobacco companies will need to win a greater share of e-cigarettes than they have in tobacco to preserve short-term margins: e-cigarette margins will be lower in the early years. The volume decline in the UK tobacco market, for example, could accelerate to as much as 10% compound annual growth rate. It appears to us that BAT is currently more advanced in its e-cigarette thinking than Imperial Tobacco. We are downgrading BAT from hold to sell (price target from 3225p to 3000p), and Imperial Tobacco from buy to hold (price target from 2900p to 2450p).

But with the stock market heading higher once more there has been no immediate impact. BAT is up 23.5p at 3560.5p while Imperial is 34p better at £23.53.