How A Possible Menthol Ban Has Made Altria An Undervalued Stock

by Trefis Team
Altria Group, Inc.
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Altria‘s (NYSE:MO) stock has nosedived almost 18% since rumors emerged regarding possible FDA action on menthol cigarettes on November 9. These fears proved true when, on November 15, FDA commissioner Scott Gottlieb issued a statement detailing steps the agency may undertake to curb youth smoking rates. Investor concern regarding this seems exaggerated given the fact that Altria isn’t a leader in either of the markets the FDA may target – menthol cigarettes and e-cigarettes. Moreover, these are still just proposals; there is no certainty it will be passed into law, and even if it does, it may take a couple of years. In this article, we’ll delve deeper into these issues, and how Altria may be able to overcome these potential losses of revenue sources.

We have a $72 price estimate for Altria, which is significantly higher than the current market price. The chart has been made using our new, interactive platform. You can click here for our interactive dashboard on Our Outlook For Altria In FY 2018 to modify the assumptions and gauge the impact on the company’s revenue, earnings, and price per share metrics.

Crackdown On E-Cigarettes

Citing the findings of the 2018 National Youth Tobacco Survey, Scott Gottlieb reported that the use of e-cigarettes and other ENDS (Electronic Nicotine Delivery Systems) had a 78% increase in current e-cigarette use among high school students, and a 48% increase among middle school students from 2017 to 2018, reversing years of favorable data. Consequently, there is a need to stop these trends, and in this regard, the FDA wants to curb their sales to age-restricted, in-person locations, and heighten age verification processes for the products sold online.

On the face of it, an FDA crackdown on e-cigarettes – one of Altria’s fastest growing segments – should worry investors. However, when the crackdown also targets one of its biggest competitors in the space, which controls close to three-fourths of the market, it may actually be the best news the company has received in a while. Just three years after its formation, Juul Labs has already reached a valuation of $15 billion, as it continues its tremendous growth in this fast increasing market. Its market share has spiked from 32% in November 2017, to 60% in April, and further to almost 73% by September. One of the reasons cited for its tremendous growth trajectory is its increasing popularity with minors due to their appealing flavors, such as mango and mint.

For Altria, in the year ended January 27, 2018, its e-cigarette brand – MarkTen – garnered close to $200 million in sales. This forms a tiny fraction of the $25.6 billion total revenues Altria achieved in FY 2017. Consequently, an action by the FDA in the e-cigarette industry should not be much of a dampener on Altria’s revenues. Moreover, according to Wells Fargo analyst Bonnie Herzog, Altria could be well positioned in the face of this action by the FDA since it is well-versed with dealing with youth access to its products and has “limited/mature flavor profiles relative to Juul.” Another factor that needs to be considered is that such a move by the FDA, to potentially take the fruity flavored e-cigarettes off the market, may, in fact, prompt many users to shift back to traditional cigarettes. A Piper Jaffray survey of 19,000 Juul users revealed that 62% had been smokers when they started to use Juul, and about two-thirds of them quit after beginning to use the product. Consequently, a crackdown on this market, particularly on Juul Labs, may put a hold on the cigarette market losing customers to the vaping industry.

The Wall Street Journal reported recently that Altria was in talks to buy a “significant minority stake” in Juul Labs. The report also stated that any deal is likely several weeks away, with a possibility of it not occurring at all. Such a move may be beneficial to both parties; for Altria, it may help to get a bigger stake in a fast-growing sector. Meanwhile, for Juul, the deal can help it to gain shelf space, as well as have a partner that is well-versed with dealing with government regulations.

Ban On Menthol Cigarettes

For Altria, in the third quarter of FY 2018, its menthol retail share was 10.2%, or approximately 20% of the company’s tobacco retail share. While it may not be a leader in this segment, these are fairly large numbers. Consequently, a ban on their sales may have a significant impact on the company’s revenues. However, the company has been witnessing declining cigarette volumes for a number of years now, and has countered its impact through price increases. This is the most plausible step that the company will undertake in the event of the proposal actually passing through.

Another factor that will provide a meaningful pullback to the declining volumes is the introduction of iQOS. 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 the go-ahead, Altria will get exclusive rights to sell these products in the country. With a product like iQOS in its portfolio, it could be a game-changer for Altria, and could ensure continued growth for the company in the future.

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