The FDA's New Nicotine Proposal Spells Trouble for Big Tobacco

The more than 50-year war that's been waged by the U.S. against tobacco companies has been working. According to the latest statistics from the Centers for Disease Control and Prevention (CDC), an estimated 15.1% of U.S. adults (36.5 million) aged 18 and older were smoking cigarettes as of 2015. That's down from 20.9% of all U.S. adults back in 2005, and more than 40% of all adults back in the mid-1960s.

Since smoking tobacco has unquestionably been linked to an increased risk for heart disease and cancer, this sizable decrease in adult smokers has undoubtedly saved lives and helped increase average life expectancies.

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However, there's a long way to go. Cigarette smoking still accounts for more than 480,000 deaths per year, or roughly 1 in every 5 annual deaths. Despite its ongoing educational campaign to curb smoking, the CDC and Food and Drug Administration (FDA) want to do more to get smokers to put down their cigarettes for good.

Puff. Puff. Live.

Late last week, the FDA unveiled its latest proposal, which could represent the first true nail in the coffin for the traditional tobacco industry. The FDA proposes cutting nicotine levels in cigarettes to levels it would deem as minimally addictive, or possibly even non-addictive. The FDA can't outright ban tobacco, but its regulatory proposals could certainly push down acceptable nicotine levels in cigarettes.

Nicotine itself isn't a cancer-causing agent, but it's what's responsible for creating the addiction that keeps consumers coming back for more, and thereby smoking cigarettes that do have cancer- and disease-causing chemicals. By lowering nicotine content in cigarettes, the FDA presumes that it'll reduce the addictive quality of tobacco -- meaning consumers will smoke less, quit altogether, or move their habit to an alternative source, such as electronic cigarettes or a nicotine patch. All of these scenarios are potentially bad news for Big Tobacco.

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It should be noted that the FDA's proposal won't simply become a new regulation. Proposals of this sort allow for public commentary and input from multiple stakeholders before any measures are officially taken. In other words, it could be months, or longer, before we have a firm idea on what could happen with nicotine regulation.

Big Tobacco has tried to cope, but it could be a struggle

In recent years, Big Tobacco has been utilizing its exceptional pricing power to counteract a fairly steady drop in cigarette volume. Altria (MO +0.00%), which operates solely in the U.S., has been almost entirely reliant on higher cigarette prices and its share-buyback program -- which has reduced its share count by approximately 175 million shares over the past decade -- to push its earnings per share (EPS) higher. 

Overseas manufacturers, such as Philip Morris International (PM +0.01%), have been a little luckier in that they have a broader geographic audience with, in some countries, far less regulatory oversight. Thus, countries like India and China continue to offer plenty of growth opportunity in the wake of the U.S.'s crackdown on Big Tobacco. Philip Morris doesn't operate in the United States, but has, instead, benefited from its global diversification.

U.S. manufacturers like Altria and Reynolds American, which is now owned by British American Tobacco (BTI 0.01%), have seen the writing on the wall for years that tougher regulations could be headed their way. As such, they've been focused on alternative-delivery platforms. Unfortunately, these alternative platforms, like electronic cigarettes, represent a nascent operating segment that is growing fast, but is still a low-to-mid single-digit contributor.

British American Tobacco is the largest vape company in the world, so among all its peers, it should be best fit to test the idea that alternative-product platforms can stem weakness in combustible products. Then again, it could be quite some time before Big Tobacco sees any sort of genuine offset from the growth in smokeless products compared to the loss in volume from combustible tobacco products.

An about-face for electronic cigarettes? Unlikely.

Though the transition toward smokeless products and alternative-delivery platforms is ongoing, perhaps the biggest surprise of the FDA's proposal was commentary from FDA Commissioner Scott Gottlieb that electronic cigarettes may offer a solution to curb tobacco use. Said Gottlieb, "While there's still much research to be done on these products and the risks that they may pose, they may also present benefits that we must consider." As Reuters points out, this commentary is consist with his position this past April that electronic cigarettes may be useful in helping to wean smokers off combustible cigarettes.

But what's truly notable here is that Gottlieb's statement goes against published studies that have shown e-cigs, as they're also known, can be quite harmful. A study by National Jewish Health in 2014 found that liquid vapor from electronic cigarettes damaged epithelial cells in users' airways within minutes, leaving them more susceptible to viral infections. The effect lasted for up to 48 hours after use.

Another study from researchers at Harvard T.H. Chan School of Public Health in 2015 wound up analyzing 51 flavored liquids for the presence of three chemicals known to have an adverse impact on a person's lungs. The findings showed that 92% of the liquids contained at least one of these three chemicals.

There have also been concerns that liquid-vapor marketing has been targeted at children, given flavors like cotton candy and bubble gum. This was supposed to be taken care of this past August when new FDA regulations were to go into effect requiring the disclosure of ingredients being used in nicotine-containing vaping liquid and the placement of warning labels on packaging. Unfortunately, these regulations were pushed back, giving electronic cigarette and liquid-vaping producers additional years to comply, or fail to adhere to, the coming regulations.

Beware the smoke-and-mirrors yield of tobacco stocks

It certainly appears that we're coming to a crossroads for the tobacco industry. At some point, consumers simply won't be able to absorb any more substantial price hikes. Further, reassurances are needed from the FDA that electronic cigarettes are "safe," in the relative sense of the word, before this Fool believes e-cigs have a shot to replace even 5%-10% of the lost revenue from combustible tobacco products. I'd suggest avoiding those delectable tobacco dividends and finding other high-yield companies to invest in until the FDA issues its final word on the matter.