What Does FDA’s Rejection Of iQOS Claims Mean For Altria?

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Recently news broke regarding the rejection of Philip Morris International‘s (NYSE:PM) proposed claim that its iQOS device presents less of a health risk than traditional cigarettes by an advisory panel instituted by the FDA. Philip Morris is currently trying to gain FDA approval to start selling its heat-not-burn tobacco device called iQOS with a reduced risk claim in the US. Once iQOS gets a go ahead, Altria (NYSE:MO) will get exclusive rights to sell these products in the US. Moreover, as Philip Morris was the first company to seek US approval to market a tobacco product as being less harmful than traditional cigarettes, they would, logically, be the first company to receive approval from the FDA, implying a significant marketing advantage over other reduced risk tobacco products. However, this latest development is a tremendous setback.

We have a $73 price estimate for Altria, which is slightly higher than the current market price.

What Had Philip Morris/Altria Hoped For?

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Laboratory tests on the aerosol of iQOS have shown significantly lower levels of harmful and potentially harmful constituents (HPHCs), and reduced toxicity than cigarette smoke. Furthermore, one 90-day study in the US and one 90-day study in Japan reported that smokers who switched completely reduced their exposure to selected HPHCs, approaching those observed in people who quit smoking for the duration of the studies. According to the company’s filing, while switching to its Modified Risk Product (MRP) iQOS is not as beneficial as quitting, it is still a considerable improvement to smoking traditional cigarettes. Hence, it would help in improving public health if the product manages to attain a high adoption rate. IQOS is currently present nationwide or in key cities in 31 markets worldwide, including Japan, Canada, Germany, Italy, and the UK.

iQOS has had considerable success in Japan, the only country where the device has been launched nationally. The brand has already garnered 13% of the total market share in the region, as reported in the third quarter earnings of the company. PM has stated that if 15% of Americans who currently smoke would switch to iQOS, it would amount to 6 million consumers making this shift. According to company estimates, iQOS has the potential of saving 90,000 lives over a 20-year period.

What Exactly Happened?

Members of the advisory panel unanimously voted against (with one abstention) Philip Morris’ claim that its iQOS product cuts the risk of tobacco-related diseases. Furthermore, the company’s claim that its heat-not-burn device is less risky than continuing to smoke cigarettes was also rebuffed in a 5-4 vote. On the other hand, one claim that they did agree on was that iQOS reduced a consumer’s exposure to harmful or potentially harmful chemicals, although they did vote against the belief that this reduced exposure would translate to a measurable and substantial reduction in morbidity and or mortality.

What Does This Mean Going Forward?

The first thing to consider is that the advisory panel’s recommendation is exactly that – it is a recommendation; it is not binding. Moreover, this recommendation is only for the purposes of its marketing, and not for its sale. This means that if the recommendations are accepted, Altria/Philip Morris would not be able to claim its iQOS device is less risky. The actual permission to sell this device is via a different application filed with the FDA. And hence, this recommendation has no bearing on whether Altria will get a green light to sell this device in the US.

Philip Morris has spent a tremendous amount of money in the development of this device, and it must have had a plan for its launch in the US in case of every possibility. Moreover, not only is the tobacco lobby in the country very strong, the current administration also seems to be anti-regulation. All these factors play into the hands of the tobacco companies.

Despite a diversified business, Altria still gets about 90% of its revenues from its smokeable products. With the smoking rate declining in the country, the company has resorted to price hikes to make up for the loss in volumes. With a product like iQOS in its portfolio, it would be a game-changer for the company, and would ensure continued growth in the future for Altria.

According to our estimates, the cigarette volumes in the US can be expected to fall to ~109 billion sticks by 2020. However, if Altria starts selling the iQOS device, which uses Marlboro Heatsticks, the volume can reach 116 billion by the end of 2020. Such a scenario could provide a 5% boost to Altria’s valuation. The charts have been made using our new, interactive platform. You can click here to modify any of the drivers and gauge its impact on Altria’s revenue, valuation, and price per share metric.

See Our Complete Analysis For Altria

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Notes:

1) The purpose of these analyses is to help readers focus on a few important things. We hope such communication sparks thinking, and encourages readers to comment and ask questions in the comment section, or email content@trefis.com
2) Figures mentioned are approximate values to help our readers remember the key concepts more intuitively. For precise figures, please refer to our complete analysis for Altria.
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