By Carol Ryan
U.S. cigarette companies are caught between hawkish regulators and the scarring experience of Marlboro-maker Altria's disastrous investment in vaping brand Juul. What is surprising is that this predicament still has the capacity to catch investors off guard.
On Monday afternoon, The Wall Street Journal reported that the Biden administration is considering tighter tobacco regulations. The trigger is a petition that the U.S. Food and Drug Administration must respond to later this month, stating whether or not it plans to ban menthol cigarettes. The White House is also weighing whether to reduce the nicotine content of cigarettes to make them less addictive.
On Tuesday, Altria fell 6% at the open, having already lost 6% shortly before the Monday close. Europe-listed peers British American Tobacco and Imperial Brands dropped 7%. Philip Morris International, which controls Marlboro overseas, has been less impacted. The company spun out its American business -- now Altria -- in 2008 precisely to fend off this kind of risk.
Investors now dumping tobacco stocks have been complacent. The dangers of a menthol ban and lower nicotine levels have been around since mid-2017, and the Democrats are traditionally more hawkish on tobacco regulation. In the latest election cycle, two-thirds of all cigarette industry donations went to the Republicans, data from lobbying monitor OpenSecrets shows.
Some may have been lulled into believing that the issue had slipped down the political agenda after a period of calm. This was the first strong indication of the Biden administration's intentions. And the tobacco business has fared well during the pandemic: U.S. cigarette volumes were flat in 2020 for the first time in years.
Cigarette companies can delay implementation for several years by dragging any fresh rules through the courts. The bar for new regulations also is high: The FDA must have science to prove that the changes will benefit public health and not simply push demand underground.
Still, the companies with most to lose from tougher regulation have made little progress in managing the risk. In 2020, Altria made 88% of net revenue from smokable products, just 1 percentage point less than in 2017. The tobacco giant's $13 billion investment in Juul Labs in 2018 is now worth just $1.6 billion, after several write-downs.
British American Tobacco made a different kind of bad bet with its almost $50 billion buyout of Reynolds American in 2017. It makes more than four-fifths of overall sales from old-school cigarettes, including through Reynolds's big menthol business, although its exposure to the U.S. market is lower than Altria's.
The news will likely sharpen investors' existing bias toward tobacco companies that have large smokeless portfolios, such as Swedish Match. Among the industry's giants, the irony is that the company most insulated from the U.S. regulatory problems has the most promising transition plan: Philip Morris, which reported quarterly results Tuesday, said smokeless products like its IQOS heated tobacco sticks generated 28% of sales over the three months through March. The stock's forward earnings multiple was just 7% higher than Altria's when the two split; now the premium is 42%.
To narrow the gap, Altria and British American need to double down on smokeless products without being panicked into overpaying for the next Juul. It isn't an easy task, nor a new one, but the Biden administration's emerging stance underlines how necessary it is.
Write to Carol Ryan at firstname.lastname@example.org
(END) Dow Jones Newswires