Altria’s Stock Tanks On Latest Proposal By The FDA

An announcement by the US Food and Drug Administration (FDA) regarding the nicotine levels in cigarettes sent tobacco stocks into a tizzy on Friday, July 28. The organization plans to limit the nicotine content in “combustible cigarettes” to non-addictive levels, in order to prevent thousands of deaths and billions of financial costs related to tobacco use. This surprising move caused stocks of tobacco companies to plummet, with Altria (NYSE:MO) plunging almost 20% at one point, before recovering to a 9.5% decline. What is most quizzical is the reason why shares in Philip Morris International (NYSE:PM) fell considering the fact that the company sells no cigarettes in the country.

Below we’ll look at a couple of scenarios that may occur, and what kind of an impact it would have on Altria.

Scenario 1: FDA’s Plan Does Not Get Passed

The first scenario is that the FDA fails in its attempts to get its plan off the ground. The current government does not seem big on passing regulations that may hurt American businesses. Moreover, given the immense lobbying power of tobacco companies, such a scenario is not an impossibility. In such a case, Altria would receive no impact on its businesses, and hence, earnings.

Scenario 2: FDA’s Plan Gets Passed

If the FDA does succeed in getting its proposal passed, it will inevitably impact the earnings of the company. Some reports suggest that if cigarettes in the future have lower levels of nicotine in them, addicts will end up smoking more to get their “nicotine fix.” Hence, the cigarette volumes for Altria could actually go up. However, this is highly unlikely. A study by the New England Journal of Medicine has shown that smoking compensation does not occur when smokers are given cigarettes with nicotine levels low enough not to be addictive. If Altria was just a cigarette company, it would have faced a significant drop in its earnings. However, Altria has a diversified business, including a 10% stake in Anheuser Busch. While the company still gets close to 90% of its revenues from its smokeable segment, there are a number of ways the company can mitigate its losses.

• 1. Focus on E-Cigarettes & Chewable Tobacco 

  The FDA’s announcement seems to be more focused on reducing the consumption of “combustible cigarettes.” Hence, the other ways of consuming tobacco, such as through e-cigarettes and chewable tobacco, could be a focus for Altria going forward. While these products provide nicotine as well, they may pose less of a harm to consumers given their non-combustible method of consumption.

  These are both markets in which Altria has a significant presence. Its smokeless products segment delivered a revenue increase of 8.6% in the latest reported quarter. The company’s leading brands, Copenhagen and Skoal, each represent more than $1 billion in annual retail sales. Moreover, in e-vapor, Nu Mark’s MarkTen brand has continued to grow its volume and retail share. It is currently the number two e-vapor brand in the country, with a national retail market share of ~13% in mainstream channels. While these segments contribute only a small proportion of Altria’s earnings currently, a shift towards these products in the future could make-up for the losses from reduced cigarette sales. A higher sell-rate of these products could also help in improving their margins.

• 2. Potential Of iQOS 

  The FDA has begun its review of Philip Morris’ modified risk tobacco product application for iQOS in late May. Once iQOS gets a go ahead, Altria will get exclusive rights to sell this product in the US. According to Reuters, Philip Morris is the first company to seek US approval to market a tobacco product as being less harmful than traditional cigarettes since the new laws were introduced. And hence, logically, if they are also the first company to receive approval from the FDA, they will hold significant marketing advantage over other reduced risk tobacco products.

  iQOS has shown significant growth in all markets it has been launched in till date. Japan is the only country in which the national expansion has occurred, and the nation has boasted the strongest growth rates for iQOS amongst all nations. In the recently released second quarter results for Philip Morris, it was noted that the product carried on with its strong sequential growth, reflected in the weekly offtake shares for Marlboro HeatSticks. The brand closed out the quarter with a weekly offtake share of 12.7% nationally

The US has seen one of the highest declines in smoking rates in the world. Hence, a fall in cigarettes volumes is a given eventuality. However, such a step by the FDA  may cause a sudden and significant drop in the volumes. One thing that needs to be considered is that it is not certain that such a proposal will get passed. And even if it does, it will take a long time before it happens. For the foreseeable future, it will have no impact on the company’s earnings, and so, the immense drop in the share price may be an overreaction by the market. Furthermore, addiction is not the only reason that people smoke, and so the decline in volumes in the future may not be as magnified as people are estimating. Moreover, if the FDA’s purpose is to reduce the smoking of cigarettes, it may actually result in better tax treatment for Altria’s iQOS product.

See Our Complete Analysis For Altria

Have more questions? Have a look at the links below:

• Price Increases Boost Revenues For Altria In The Second Quarter
• How Will The Hunter’s Bill Help Tobacco Companies?
• How Will The California Cigarette Tax Hike Impact Altria?

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