TALK­ING POINT

FDA weighs in on va­p­ing: four key ques­tions for in­vestors in to­bacco stocks

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On 12 Septem­ber 2018 the com­mis­sioner of the US Food and Drug Ad­min­is­tra­tion (FDA) Scott Got­tlieb set in mo­tion plans for a crack­down on youth va­p­ing.

This in­ter­ven­tion was taken pos­i­tively by in­vestors in to­bacco stocks with both Bri­tish Amer­i­can

To­bacco (BATS) and Im­pe­rial Brands (IMB) briefly ris­ing in the af­ter­math – some­thing that share­hold­ers haven’t seen for some time as the sec­tor has been long out of favour.

1 WHAT HAS THE FDA SAID?

Among the most pow­er­ful of US govern­ment agen­cies, the FDA has re­spon­si­bil­ity for mon­i­tor­ing the safe con­sump­tion by Amer­i­cans of more than $2.4tn worth of med­i­cal prod­ucts, food and to­bacco items.

Got­tlieb says there is an ‘epi­demic’ of younger users switch­ing on to flavoured elec­tronic or e-cig­a­rettes. He’s pledged to halt sales of these types of prod­uct if ma­jor man­u­fac­tur­ers can’t prove they are tak­ing suf­fi­cient ac­tion to keep them out of the hands of chil­dren and teenagers.

The firms be­hind the Juul, Vuse (part of Bri­tish Amer­i­can To­bacco’s port­fo­lio), MarkTen XL, Blu (owned by Im­pe­rial Brands) and Logic brands, ac­count­ing for 97% of e-cig­a­rette sales in the US, are be­ing given 60 days to sub­mit ‘ro­bust’ plans to pre­vent youth va­p­ing. If these plans aren’t seen by the FDA as hav­ing gone far enough then it could or­der their prod­ucts off the mar­ket.

2 WHY IS IT SIG­NIF­I­CANT?

The news could act as a hand­brake on an in­dus­try which has grown rapidly in re­cent years as it has been seen as a safer al­ter­na­tive to smok­ing to­bacco. Mar­ket in­tel­li­gence firm Euromon­i­tor put global sales of e-cig­a­rettes at £0.5bn back in 2009 but this cat­e­gory is now head­ing to­wards the tens of bil­lions mark world­wide.

Un­sur­pris­ingly to­bacco man­u­fac­tur­ers have made at­tempts to mus­cle in on the ac­tion, though these so-called ‘next-gen­er­a­tion prod­ucts’

BRI­TISH AMER­I­CAN TO­BACCO HAS IN­VESTED $2.5BN IN THE DE­VEL­OP­MENT AND COM­MER­CIAL­I­SA­TION OF NGPS SINCE 2012

or NGPs still make a rel­a­tively lim­ited con­tri­bu­tion to over­all sales, less than 4% for Bri­tish Amer­i­can To­bacco in the first half of 2018, for ex­am­ple.

NGPs are also sig­nif­i­cantly lower mar­gin than tra­di­tional to­bacco prod­ucts.

3 WHY DID SHARES IN TO­BACCO COM­PA­NIES RISE ON THE NEWS?

The key rea­son why tra­di­tional to­bacco man­u­fac­tur­ers saw their shares surge in re­sponse to the FDA crack­down is that the clam­p­down on youth va­p­ing ef­fec­tively re­duces a com­pet­i­tive threat from Sil­i­con Val­ley start-up Juul.

Juul launched in 2015 and has been a ma­jor mar­ket dis­rup­tor, tak­ing more than 70% of the US mar­ket. The com­pany is seen as par­tic­u­larly vul­ner­a­ble to ac­tion from the FDA due to its pop­u­lar­ity among younger users and em­pha­sis on flavours.

In­vest­ment bank Jef­feries says any­thing that slows down Juul’s mar­ket share growth is a pos­i­tive for the main to­bacco groups.

Liberum’s to­bacco an­a­lysts com­ment: ‘All things equal, greater bar­ri­ers to e-cig­a­rettes are a win on the mar­gin for (tra­di­tional) cig­a­rettes, which are more prof­itable and higher ROIC (re­turn on in­vested cap­i­tal) for to­bacco man­u­fac­tur­ers.

‘Juul has be­come cool among youth in a way that few, if any, can repli­cate. One thing that is clear is that nico­tine ad­dicted youth will need to go some­where to sus­tain their ad­dic­tion. Re­search has shown that youth e-cig users are more likely to be­come smok­ers. As en­force­ment ratch­ets up, it will be crit­i­cal to see how ad­dicted youth re­spond.’

Liberum’s an­a­lysts also be­lieve a crack­down on the use of flavours in va­p­ing prod­ucts could re­duce their at­trac­tive­ness and drive smok­ers back to tra­di­tional cig­a­rettes.

4 WHAT HAP­PENS NEXT?

It ul­ti­mately de­pends how firm a line the FDA takes with the in­dus­try. Pod-based e-cig­a­rettes are also un­der scru­tiny and Liberum notes this could be a fur­ther dis­ap­point­ment as they ‘were a part of the mar­gin story for e-cig­a­rettes’.

Us­ing the time­line out­lined by the FDA, its next move could come in mid-Novem­ber. Even if this move is seen as a pos­i­tive for the en­trenched tra­di­tional op­er­a­tors in the short-term, it is worth con­sid­er­ing the long-term im­pli­ca­tions as NGPs were seen as the in­dus­try’s main pro­tec­tion against stiff­en­ing global rules gov­ern­ing tra­di­tional cig­a­rettes and de­clin­ing lev­els of smok­ing among younger peo­ple.

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