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Could you imagine what would happen to Coca-Cola stock if the government banned sugar? That's exactly the situation Lorillard (NYSE: LO ) is facing as the U.S. government considers banning menthol cigarettes, which accounted for 91.5% of the company's sales in 2009. Menthol cigarettes accounted for 30% of all tobacco sales in 2009.
Menthol is a compound found naturally in mint plants. According to The Wall Street Journal, menthol "acts as a local anesthetic and provides a cooling sensation in the mouth and throat, similar to that of a mentholated cough drop. Critics say the flavoring masks the harsh take of cigarettes, making them more appealing to young people. A federal survey published in 2009 showed that 45% of smokers aged 12 to 17 use menthol brands."
Critics such as the Centers for Disease Control and Prevention also argue that "menthol can make it easier for a smoker to inhale deeply, which may allow more chemicals to enter the lungs. Menthol in cigarettes does not make smoking safer. In fact, menthol may even make things worse."
Next week, a special Food and Drug Administration tobacco advisory committee will review data on menthol products. In March, the panel will recommend whether to ban menthol cigarettes completely if such prohibition would be appropriate for the public health.
Now a recommendation to ban menthol is just that, a recommendation. The FDA still has final say as to what will happen and doesn't have a deadline to make any decisions. So the company is safe for at least a little while. However, in the long term if the FDA bans menthol, it would be a disaster for Lorillard.
Lorillard's largest brand is Newport, a menthol-flavored cigarette that accounts for more than 90% of the company's sales. If the company is forced to switch to regular cigarettes, it's bound to lose tons of customers and take major losses, and will have to restructure to meet the new requirements. Reynolds American (NYSE: RAI ) could also take a small hit since some of its products use menthol flavoring.
Altria (NYSE: MO ) and Vector Group (NYSE: VGR ) don't have this problem. Menthols do not make up a significant portion of either of their businesses. In fact, in a stroke of competitive genius, Altria helped craft the Family Smoking Prevention and Tobacco Control Act, which required the FDA to review menthols. The company is set to benefit the most, should the FDA ban menthols, as Altria's increased dominance over the U.S. market would be almost immediate.
That said, this episode illustrates why I believe Philip Morris (NYSE: PM ) is the best way to invest in tobacco. Spun off from Altria, the company sells its cigarettes around the world, excluding the U.S. and China. The main advantage is that legal decisions against the company in one part of its market (one country) don't automatically apply across its entire market, as it does when a company loses a legal battle in one state and the ramifications apply in the rest of the U.S.
However, Fool analyst Morgan Housel calls Altria "probably the world's greatest investment." Click here for the free special report that tells you why The Motley Fool owns Altria, and provides four other companies The Motley Fool owns that you should, too.