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FDA-approved cigarettes, anyone? They sound almost as exciting as Soviet-era cars.
With last week’s House and Senate approval of the Family Smoking Prevention and Tobacco Control Act, it’s all over but the crying for U.S. tobacco companies, as the bill looks to become law shortly. The new legislation will allow the FDA to have a hand in tobacco product standards and advertising guidelines. Big Tobacco will also have to ante up to pay for the tighter regulation ($85 million up front and up to $700 million annually within 10 years, according to The New York Times).
As we’ve discussed before, Altria (NYSE: MO ) actually supported this legislation, which is funny because if the new regulation prevents folks from smoking, then wouldn’t that halt the growth of Altria’s primary business? Well, no, since Altria is already the leader in a declining market with legislation that would regulate development of new products. That’s why Altria's competition was strongly against the bill.
Big Tobacco is looking out for you
You can’t say the tobacco companies (other than Altria) didn’t try to thwart this legislation. Take the advertisement that Lorillard (NYSE: LO ) placed in The Wall Street Journal two weeks ago. The company states that FDA regulation of what it calls an “inherently dangerous product” doesn’t align with the objective of keeping you, the consumer, safe. But in the next gasping breath, Lorillard claims the legislation could lead to black-market tobacco smuggling and potentially prohibition, not to mention the stifling of “safer” tobacco product development.
One reason for Lorillard’s concern is the potential for the FDA to eliminate menthol-flavored products, a move that would tear into the firm's Newport brand. The brand is the lifeblood of Lorillard’s business, making up more than 93% of the company’s 2008 sales. Although the legislation does allow such a move, the FDA is initially prohibited from banning menthol.
Reynolds American (NYSE: RAI ) , parent of R. J. Reynolds Tobacco Company, has been fairly vocal about its disapproval of the FDA regulation for a variety of factors, including stalled “product innovation.” With President Obama committed to signing the bill, Reynolds has said that it will continue to vie for new business and emphasized that this legislation has been years in the making, so the company is not unprepared for the changes.
British American Tobacco (NYSE: BTI ) and Vector Group (NYSE: VGR ) , while against the legislation, have been more quiet in their disapproval. Vector’s development of lower-nicotine products could position it well in this new FDA-regulated world, although the legislation could, of course, make it harder for new products to be approved. British American could also face issues with marketing its smokeless “snus” (now sold only outside the U.S.) in light of the new legislation.
Burnt-out investment opportunities?
FDA regulation of the tobacco industry is only a small piece of the puzzle when it comes to forecasting the potential of tobacco stocks. To me, the growing cigarette tax on consumers is the biggest barrier for stock growth in this industry. With a pack of cigarettes costing $5 or more in some states, the price of smoking continues to increase in an economy where job losses are near the double digits and the future financial picture is uncertain at best. And cigarette taxes are proven to decrease cigarette use: In New York State, the number of smokers declined by 12% in one year after a near-doubling of state tobacco taxes.
Tobacco companies can’t complain that they’re being singled out for tax increases and government intervention. Possibilities for sin taxes abound in this struggling economy, with potential tax increases in the pipeline for brewers and spirit manufacturers, such as Boston Beer Company (NYSE: SAM ) (the maker of Sam Adams) and Diageo (NYSE: DEO ) .
Will that make sin stocks less attractive? Solid dividends, such as those from tobacco firms, can help investors stomach struggling sales for awhile, and those who are addicted probably don’t care how much cigarettes cost. With that said, however, these taxes do motivate people to cut back on their consumption and prevent younger folks from getting started in the first place.
We know that the true effects of regulation can be different from what is intended, so it will be interesting to see if Altria’s market leadership position gives it the competitive advantage that its competition believes it will gain with heightened government intervention. We’ve seen that FDA leadership hasn’t been a huge factor in drug approvals, but that doesn’t mean that FDA chief Margaret Hamburg’s past toughness on smoking won’t hurt the industry as well.
In any case, the combination of increased taxes and FDA regulation of tobacco products certainly won’t help the industry’s future growth prospects in the United States.
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