Altria Group (NYSE:MO) is having a tough few weeks. After reporting tepid first-quarter earnings results April 30, the tobacco giant is now facing an investigation from the U.S. International Trade Commission (ITC).
Along with Philip Morris International (NYSE:PM), Altria is facing an inquiry after three business units of British American Tobacco (NYSE:BTI) filed a complaint with the ITC regarding an alleged infringement of patents pertaining to the technology of heated tobacco products.
For you newbies, a heated tobacco product, at times known as a heat-not-burn (HnB) device, is a smoke-free answer to traditional tobacco cigarettes.
These devices heat the substance inside until it evaporates, distributing an aerosol that is considered less harmful than smoke. HnB devices are similar to e-cigarettes and vaping products, which vaporize a water-based liquid laced with preservatives and nicotine. However, HnB products are used with specially designed tobacco sticks that respond to the heating and evaporation process that's built in.
Problems over patents
Hands down, one of the world's most popular heat-not-burn products is PMI's iQOS system, which was only recently approved for sale in a few select local markets in the United States through an arrangement with Altria under the latter's Marlboro brand.
Given the shrinking market for traditional cigarettes in the U.S., iQOS could be a massive boon for PMI and Altria. But British American Tobacco alleges that the product infringes on its patents and intellectual property.
In response to the filing, the ITC said it found grounds to scrutinize PMI and Altria's import and patent activities. Its investigation, to determine whether PMI and Altria violated section 337 of the Tariff Act of 1930, will be carried out by the commission's Office of Unfair Import Investigations. Section 337 prohibits imports from companies that could likely infringe upon the authority of a U.S. patent owned by another person or entity.
In addition to the complaint filed with the ITC and another put forth in Germany, British American Tobacco filed a lawsuit in a federal district court in Virginia to take on the alleged infringement. BAT and its tobacco and e-vapor units want iQOS products banned in the U.S. unless PMI and Altria agree to pay out on a license to use the patents in question to maintain iQOS sales.
Poor news for investors?
The U.S. Food and Drug Administration (FDA) approved PMI and Altria's premarket tobacco applications for iQOS in 2019, affirming that the companies could begin selling iQOS devices and heat sticks (the tobacco) in select cities late in the year. If the ITC ends up enacting a ban on imports of the product for patent infringement reasons, it could be an embarrassment for two of the world's largest tobacco companies.
From an investing standpoint, the investigation may be worrisome for investors of Altria and PMI. Again, Altria's first-quarter earnings were tepid; sales of the iconic Marlboro brand were down more than 1% this quarter compared with last year. PMI's first-quarter earnings, meanwhile, showed a slight decline in shares for the retail cigarette segment, while iQOS was a bright spot.
British American Tobacco is itself the subject of a criminal investigation led by the U.S. Department of Justice and the Treasury Department, alleging that the company breached international sanctions by doing business with nations including Cuba and Iran.
That said, of all the companies involved in this dispute, British American Tobacco and its units look the most like a buy. That's especially true given BAT's coronavirus vaccine candidate, which is poised to enter human trials. Investors interested in the tobacco space will want to look closely at the moves each company is making beyond traditional cigarettes.