On Jul 28, the U.S. Food and Drug Administration (FDA) proposed to lower nicotine levels in cigarettes, as it is responsible for a number of health issues. Following the proposal, stocks of cigarette makers including Altria Group Inc. (MO - Free Report) , British American Tobacco p.l.c. (BTI - Free Report) and Vector Group Ltd. (VGR - Free Report) plunged 9.5%, 7.0% and 4.7%, respectively. Shares of Philip Morris International Inc. (PM - Free Report) declined initially but then rebounded to eventually close 0.27% higher.
If we look into the share price performance of these tobacco stocks in comparison with the industry, we note that except Philip Morris, all the other stocks have underperformed the industry that gained 8.9% in the past six months. While Philip Morris gained 22.2% and British American increased 1.5%, Vector Group and Altria declined 9.5% and 8.4%, respectively, in the same time frame.
Tobacco causes cancer and heart disease and is responsible for more than 480,000 deaths annually in U.S. Tar and other substances inhaled through smoking make cigarettes deadly, but the nicotine in tobacco is what makes them addictive.
Also, governments around the world are imposing restrictions on tobacco companies which, in turn, are lowering cigarette consumption. FDA has made it mandatory for tobacco companies to use precautionary labels on cigarette packets to dissuade customers from smoking.
In May 2016, the FDA also imposed several restrictions on e-cigarettes. The FDA made it mandatory for all tobacco makers to seek marketing authorization for any tobacco product introduced after Feb 15, 2007. The law was extended to include e-cigarettes, pipe tobacco, cigars and hookahs.
Recently, the state government in India's capital directed Philip Morris and other tobacco companies to remove all advertisements in the city, warning them of legal action if they do not comply.
Moreover, the European Union and the FDA have proposed a ban on menthol in accordance with the Tobacco Control Act. Per the act, menthol have an adverse effect on health and thus should not be used in any product. Moreover, this ban will create a serious black market for these products, which would be detrimental to all tobacco companies.
While the news of cutting nicotine to non-addictive or minimally addictive levels have raised concerns of rapid declines in sales for traditional cigarettes, it has also proved a boon for e-cigarettes, which turn liquid nicotine into an inhalable vapor. Though the regulatory authorities have imposed marketing and product regulations on e-cigarettes as well, but there is still not much scientific evidence to back their ability to help smokers quit or reduce the habit of smoking. We also note that FDA has pushed back its reviews for products like cigars and hookah tobacco until 2021 and e-cigarettes until 2022.
Focus on Tobacco Alternatives
Amid declining smoking rates, the tobacco giants have resorted to innovation in the form of e-cigarettes and Reduced Risk Products to mitigate losses from an increasing number of quitters. This is particularly encouraging as according to Euromonitor International, the global e-cigarette market is expected to grow to $51 billion, or hold 4% share of the worldwide tobacco market, by 2030.
Altria is steadily expanding presence in the e-cigarette market with its MarkTen and Green Smoke brands. Moreover, in an attempt to boost unconventional tobacco products, Altria acquired privately-held Sherman Group Holdings, LLC and its subsidiaries (Nat Sherman). The move is likely to expand its premium smokeable category. The takeover benefits Altria’s smokeable segment and complements Altria’s Marlboro brand which also falls under the premium category.
Similarly, to cater to the new consumer preferences, Philip Morris launched the much talked about iQOS, a smokeless cigarette in Nov 2014 leading the tobacco industry’s push into reduced-risk products that may eventually replace traditional smokes. Philip Morris’ iQOS smokeless cigarette looks like a second generation vaporizer that uses actual tobacco in the shape of small Marlboro cigarettes called HeatSticks that are heated at high temperatures, but not burned.
Since its launch, there has been a steady increase in the number of iQOS purchasers. iQOS are anticipated to boost market share and offset declining volumes in traditional cigarette business in 2017. The company has launched iQOS in key cities in 27 markets globally during second-quarter 2017 and remains on track to expand nationally in 30 to 35 markets by the end of the year.
The marketing and technology sharing agreement between Philip Morris and its peer Altria Group is also boosting the business of both the companies. Per the agreement, Philip Morris will market Altria’s MarkTen e-cigarettes internationally and Altria will distribute two of Philip Morris’ heated tobacco products in the U.S. The companies have also extended their technology-sharing agreement in Jul 2015 to work on a joint research, development and technology-sharing framework for developing unconventional cigarettes.
On Mar 31, Philip Morris has applied for pre-market approval of its iQOS heated tobacco product with the U.S. Food and Drug Administration, which will be sold by Altria in the U.S., provided the FDA grants Philip Morris’ request. Such a collaboration is encouraging as it will help the participating companies maintain market share amid declining volumes and growing awareness against tobacco products.
The recent merger of Reynolds American, Inc. with British American Tobacco has brought strengthen its global portfolio including next generation products and strong cigar brands including Newport, Kent from British American Tobacco and Camel and Pall Mall from Reynolds. Moreover, the combined company will benefit from Reynolds’ strong position in the alternative tobacco and next-generation product development, and R&D capabilities.
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