Tobacco Latest FDA announcement to impact the sector
The US Food & Drug Administration (FDA) recently announced a “new comprehensive plan for tobacco and nicotine regulation” (28 July 2017). This plan would provide necessary scientific and regulatory background to implement the Family Smoking Prevention and Tobacco Control Act (2009, giving the FDA the authority to regulate the manufacture, distribution, and marketing of tobacco products). In the announcement, the FDA stressed its desire to “open a public dialogue on lowering nicotine levels in combustible cigarettes to non-addictive levels”. As well as its commitment to encourage “innovations that have the potential to make a notable public health difference and inform policies and efforts that will best protect kids and help smokers quit cigarettes".
The FDA’s announcement hit the tobacco companies the most exposed to the US market such as Altria (-9.5% on 28 July, -2.9% on 31 July) who operates exclusively in the US. With 40% of its revenues exposed to the US market after the acquisition of Reynolds American, British American Tobacco also suffered (-6.8%, -5.0%). The announcement also weighed on Imperial Brands’ performance (-3.8%, -5.9%) in spite of a more limited exposure to the market (11% of revenues). However, this downside proved short-lived. At the other end of the spectrum, Japan Tobacco (+1.8%, -1.6%) and Philip Morris International (+0.3%, -1.5%) proved resilient (negligible exposure for the former and no US exposure for the latter). Despite 37% revenue exposure to the US, the downside for Swedish Match (-3.9%, -1.0%) was also limited thanks to its unique product offering (snus and moist snuff, chewing tobacco, cigars, matches and lighters, no cigarettes).
The FDA demonstrated a “greater awareness” of nicotine products’ continuum of risk with regular cigarettes at the very top. The federal agency is aiming for “an appropriate balance between regulation and encouraging development of innovative tobacco products that may be less dangerous than cigarettes.” On this basis, we anticipate an increasing FDA’s support to research into smokeless tobacco and next-generation products. For now, there is limited visibility on the evolution of the regulatory framework for nicotine and flavoured (menthol) combustible cigarettes and the impact on the US tobacco industry. It also seems very likely that regulation in other developed countries will follow a similar path. Such development will prove harmful to the tobacco industry with no doubts.
We are also in the camp that the main tobacco players will push for a strict regulation of next-generation products. While product offering in this fast growing niche market has been exponential,the main tobacco players are still in the early stages of product development/ test. However, we believe that these are better equipped to face new regulation and standards compared to newcomers thanks to their vast operations, significant financial resources and experience. On this basis, a highly regulated market for next-generation products could benefit big tobacco and may be an opportunity for them to gain a leading position similar to the one in the combustible cigarettes market.
Overall, we take a cautious stance on the tobacco sector despite its high profitability, solid cash flows and generous shareholder remuneration policies. We expect the uncertainty following the FDA announcement to come as an additional burden on top of the global volume decline and already high sector valuation. Note also that we lowered our target price for both British American Tobacco and Japan Tobacco – our preferred names in the sector – post 1H17 results publication.
Kristof De Graeve
Data & recommendations as of 02 October, 2017 close
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