Altria (MO 0.70%) once thought it was best positioned to take over the reduced-risk market with an ownership stake in the leading electronic cigarette manufacturer, Juul Labs, and a marketing agreement with Philip Morris International (PM 3.83%) to sell its leading IQOS heated tobacco device in the U.S. The one-two punch would set the cigarette maker atop the rapidly growing e-cig market.

All that went up in smoke after Juul was blamed for rising teenage e-cig usage and its once-dominant market share evaporated. Then the IQOS was banned from being imported into the U.S. because it violated British American Tobacco's (BTI 0.51%) patents. That combination all but knocked Altria out of the e-cig market.

Person wreathed in a cloud of vapor.

Image source: Getty Images.

While a workaround to the import ban was being developed, Philip Morris announced it was buying nicotine lozenge maker Swedish Match, which many feared would cut Altria out of the loop since the acquisition gives the global tobacco company direct access to the U.S. market. That's now been confirmed as the two cigarette companies just announced Altria's distribution deal for IQOS has been rescinded in exchange for $2.7 billion. 

So with Juul's business withering, IQOS no longer an option, and no reduced-risk product of its own to bring to market, Altria's position in vaping looks bleak. Here's why investors shouldn't be disheartened.

Going their separate ways

While the agreement between Altria and Philip Morris has been rescinded, it actually doesn't officially take place until April 2024. Philip Morris is reportedly planning on reintroducing a domestically produced IQOS sometime next year. If there's supply available before the 2024 deadline, Altria would still have the right to commercialize the device under the Marlboro HeatSticks brand. 

Although Philip Morris wants back into the U.S. market, a potentially lucrative $20 billion profit opportunity, it's hard to imagine it will actually produce enough product for Altria to sell. Because Altria owns the right to the Marlboro brand, when the 2024 deadline arrives, Altria takes the brand with it. Philip Morris would no longer able to use it. 

It would make little sense to build up a market for a product that it will be unable to sell in a few months' time. Moreover, since Altria will undoubtedly end up using the Marlboro name for itself, Philip Morris would in essence be developing a market for what will become a rival. As a result, it's hard to see an IQOS device coming to market before the commercialization agreement expires.

And that's OK.

How Altria bounces back

Philip Morris paid Altria $1 billion upon signing the agreement to dissolve their commercialization pact. It will pay another $1.7 billion, plus interest, by July 2023. Altria is going to use that money to invest in its own reduced-risk product portfolio, pay down debt, and possibly even stock buybacks, market conditions permitting.

Altria says it has designs for two brand-new smoke-free products, including its own heated tobacco product, that it plans to introduce by the end of the year. And while it agrees with other cigarette companies on a smoke-free future, the company is taking a "portfolio approach" to harm reduction.

In addition to pursuing electronic cigarettes, Altria has a number of other oral tobacco products available that generated more than $2.6 billion in revenue last year and carried operating profit margins north of 63%. This is significant considering its cigarette products have margins of 45%. They include:

  • Moist smokeless tobacco, led by the Copenhagen brand, that has a better than 29% share of the market.
  • On! nicotine pouches, which have a 3.8% share of the market.
  • Verve tobacco-less nicotine discs, four of which have gained FDA market approval.

There's also the distinct possibility Altria could buy its way back into the e-cig market, acquiring a company like NJOY. While NJOY currently has a minuscule share of the market, it does have FDA-approved e-cigs that Altria could immediately begin selling. The new designs Altria plans on introducing by year end still need to go through the lengthy FDA approval process, so an acquisition would let it hit the ground running.

Ready for the next leg up

The e-cig market is one that's still in a state of flux. British American Tobacco's Vuse device is currently gaining share, but a new Altria device marketed under the Marlboro brand, which still owns nearly half the traditional cigarette market, would be a potent competitor.

Losing the IQOS agreement certainly stings, but it was not unexpected, and the $2.7 billion payment is an acceptable salve. Down 25% from recent highs, trading at just eight times next year's earnings, and with a safe, healthy dividend yielding 8.6% annually, Altria is a discounted stock that has many levers yet to pull. I certainly won't be selling any of my shares in this valuable tobacco stock.