Because the Food and Drug Administration is not shying away from the battle with the tobacco industry over regulating the amount of nicotine in cigarettes, investing in tobacco companies like Altria (NYSE:MO), British American Tobacco, or discount cigarette maker Vector Group might not seem like a good idea.
Although the FDA is prohibited by law from banning cigarettes outright or mandating there be no nicotine in them, that doesn't mean it can't use a backdoor method to severely limit tobacco companies' operations.
Even so, investors can still find tobacco stocks worth buying. In fact, industry giant Altria is the one tobacco company you should consider before all others.
Technology comes to the cigarette
The tobacco industry is going smoke-free. Like it or not, a decline in smoking and increased regulation are forcing the industry to devise alternatives. And although the U.S. is behind other countries in encouraging the use of reduced-risk alternatives, the landscape could be changing -- and that will benefit Altria the most.
Philip Morris International (NYSE: PM) is not only pursuing efforts to market and sell its next-generation heat-not-burn iQOS electronic cigarette, it's also trying to gain a modified risk label for the device. If successful, the iQOS will be sold under Altria's Marlboro brand as HeatSticks per an arrangement between Philip Morris and Altria.
In other countries where it has been introduced, the iQOS has quickly gained market share; in Japan, where it has been sold the longest, unit shipments of the device now outstrip those of traditional cigarettes. There may be cultural differences that have allowed the iQOS to become the dominant brand in that country, but with the share gains seen elsewhere, it seems safe to assume Marlboro HeatSticks could enjoy strong consumer acceptance if they were allowed to be sold in the U.S., particularly as a reduced-risk product.
That's because for a company to earn such a designation, the FDA requires manufacturers go through an expensive and labyrinthine application process. Only the biggest, most financially well-off companies can afford to do so, which will limit competition. Altria would have a virtual monopoly on being able to promote the product as being a safer alternative for smokers.
Alternative tobacco products
Altria is not putting all its eggs in the iQOS basket, but says it is committed to being "the U.S. leader in authorized, noncombustible, reduced-risk products." To that end, the tobacco giant's U.S. Smokeless Tobacco subsidiary filed an application with the FDA to allow its Copenhagen brand of snuff, a moist smokeless tobacco product, to get a modified risk designation. It also plans to submit additional reduced-harm applications for a range of noncombustible tobacco products. There's a lot of promise in pursuing that route.
In late 2016, Swedish Match (NASDAQOTH:SWMAF) tried to have the FDA remove a warning label from a snuff-like product called snus that said it caused gum disease and tooth loss. It also wanted a reduced-risk label. While the agency denied the warning label request because it said snus could cause those ailments, it held off on ruling whether Swedish Match could claim snus is less harmful than cigarettes because it believed the company could refile an application "supporting issuance of modified risk orders."
Now British American Tobacco's U.S. unit, Reynolds American, has numerous applications before the FDA seeking such a designation for its own snus products. Its Camel brand of snus owns three-quarters of the U.S. market.
It's clear that these cigarette alternatives are the area where the tobacco industry may see the greatest growth. And Altria, as the biggest player with the chance to benefit the most from efforts to change the industry's course, is the one company investors should consider buying.
A discounted valuation
Shares of Altria are down 16% so far this year and have lost nearly a quarter of their value from the 52-week high they hit last summer. The stock trades at just 16 times earnings and 13 times next year's estimates, while paying a dividend of $2.80 per share that currently yields 4.7% annually. There is also the persistent rumor that Altria and Philip Morris International will soon join forces again through a merger to better compete globally.
If Philip Morris can win the day with its iQOS Marlboro HeatSticks and Altria can get its own noncombustible tobacco products a reduced-harm label, that could be the catalyst for change. It also means that Altria will be the one tobacco company that will soar above the rest in this brave new smoke-free future.