FDA menthol ban will be a slow burn
U.S. regulations will take time, but make Big Tobacco stocks a less predictable bet
The Food and Drug Administration’s war on menthol cigarettes could take years. Investors have time to sift the ashes and decide which tobacco stocks are best prepared for tougher U.S. regulations and a shift to alternative forms of smoking. FDA Commissioner Scott Gottlieb last week said he wants to ban menthol brands, which are more addictive than regular tobacco, but didn’t give a timeline. He will immediately restrict sales of flavored e-cigarettes to fight rocketing use among young Americans—3.6 million middle- and highschool students are now esmokers, up from 2.1 million in 2017. That will hurt rapidly growing Juul Labs. The electronic cigarette startup makes 58% of group sales from the flavored tobaccos that will be restricted under the new rules, Bernstein estimates.
The proposed menthol ban is a big problem for established tobacco players. Investors have wiped a combined $35 billion (U.S.) off the value of Altria and British American Tobacco since news reports of an FDA crackdown emerged earlier this month. Lucky Strike owner BAT, which makes a fifth of its operating profit from minty brands like Newport in the U.S., according to UBS, has been worst hit.
But any restrictions will take time. The FDA needs to meet a high bar for a ban and the con- sensus in the industry is that Mr. Gottlieb doesn’t yet have the scientific evidence he needs. Big Tobacco would almost certainly mount legal challenges that could drag through the courts for years. That gives tobacco investors time to figure out whether U.S. menthol smokers are likely to quit, switch to traditional tobacco or opt for alternatives.
For investors, the most promising cigarette alternative is IQOS, a supposedly smokeless heated-tobacco product developed by Philip Morris International, which sells the Marlboro brand outside the U.S. Following investments totaling $5 billion in recent years, so-called lower-risk smoking products generated 13% of PMI’s group sales in the nine months through September. Altria has the exclusive right to sell IQOS in the U.S. if it receives regulatory approval. The FDA may weigh in early next year.
BAT has developed a heated tobacco product to rival IQOS, but is much further behind. Its early efforts to invest in cigarette alternatives focused on vaping. As the meteoric rise of Juul in the U.S. has demonstrated, this is a classic consumerelectronics industry with few barriers to new entrants.
Longer term, the question for shareholders is whether tougher regulation will make the in- dustry’s big dividends unsustainable. An average yield of 6.3% for the top three players is more than triple the S&P 500 average. While Big Tobacco weathered a global wave of smoking bans in bars a decade ago with its profits intact, concerns are growing that the industry will finally be disrupted by better alternatives to cigarettes. Add a more hard-line FDA and tobacco is becoming a less dependable bet.