If you're a smoker, you know it's been a rough ride over the past two decades. Advocacy groups have been increasing awareness regarding the dangers of smoking since the early 1990s, and even more recently, both the Centers for Disease Control and Prevention and the Food and Drug Administration have been tag-teaming the tobacco industry to bring light to these dangers.
Last March, the CDC announced a $54 million, three-month graphic advertising campaign targeting TV, radio, print, billboard, and online viewers in the hope of getting 50,000 smokers to quit. Just weeks later, the FDA hit the tobacco industry with a request to be supplied with the quantities of 20 chemicals in cigarettes known to cause cancer, lung disease, and other health problems, including formaldehyde, carbon monoxide, and ammonia. The FDA plans to release its findings to the public next month in the hope that increased awareness will reduce the amount of active smokers.
Big Tobacco's big worry
Yet for all of these concerns, none may be more pressing for Big Tobacco companies such as Altria (NYSE:MO), Lorillard (UNKNOWN:LO.DL), and Reynolds American (NYSE:RAI) than what mayor Michael Bloomberg is doing in New York City.
In 2011, Mayor Bloomberg passed a ban outlawing smoking on New York City's beaches, public plazas, boardwalks, and parks. Since then, Bloomberg has taken numerous other supposed "vices" to the woodshed, including sugary drinks, which he banned in any amount greater than 16 ounces within the city, and Styrofoam trays, which were the latest item to fall under his legislative guillotine. Many of you are probably of the opinion that the actions of one little old mayor probably don't make a lot of difference ... until you see Bloomberg's track record according to Forbes.
In December 2006, a Bloomberg initiative went into effect that required restaurants to include calorie values on menus and menu boards. This was done to combat rising obesity within New York City, and not surprisingly, visible calorie values have become a norm throughout much of the country. Also in December 2006, a Bloomberg initiative to ban trans-fats within the city was passed by the Board of Health and gave restaurants 18 months to completely remove them from their foods. Lo and behold, not only did McDonald's (NYSE:MCD) stop using cooking oil that was trans-fat free in New York City by the deadline, but it had also stopped using trans-fat oils throughout North America.
To sum up: When Bloomberg takes action, the result is often much bigger than what occurs within the city of New York.
The question then becomes whether this is a major problem for domestic tobacco companies. I'm going to go out on a limb based on Bloomberg's previous track record and venture my best guess by saying "yes," that this has a chance to become a progressively tougher ban that could threaten to sweep to other cities.
The trend is not your friend
Domestic cigarette sales have been in a steady decline for decades, as a National Health Interview survey demonstrates:
Part of this trend can be attributed to better safety awareness regarding the effects of smoking on the body by the CDC, while the other half comes from aggressive state taxation aimed at taking a bite out of consumers' pocketbooks if they choose to smoke. Not surprisingly, New York City leads all cities in the U.S. in terms of highest combined state and local taxation, at $5.85 per pack, followed closely by Chicago at $5.64 per pack and Evanston, Ill., at $5.48 per pack. Keep in mind that these figures exclude the $1.01 federal tax on tobacco packs, If these figures seem high, then Bloomberg gets even more fuel for his fire when estimates from the CDC for the overall costs of lost productivity and health-care costs on a per-pack basis came back at $10.47.
We've seen negative effects for years on domestic tobacco producers, which have countered with everything from share repurchases, higher prices, and bigger dividends to mask investors from the fact that their business model is deteriorating. In 2011, Altria announced that it'd be laying off 15% of its workforce in response to declining tobacco volumes. Reynolds American followed shortly thereafter in March 2012 by announcing that it, too, would be shedding 10% of its workers to trim costs. Lorillard has been able to largely escape the layoff bug because of the sales balance between its premium Newport brand and its lower-margin, but strong-selling, discount brands. However, even it could become susceptible if Bloomberg's smoking-ban initiatives prove to have a positive health and productivity benefit over time.
This leads to the next question: Is there a smart way to play the tobacco sector?
Think global if you want to play tobacco
The answer is yes, but it's not by looking toward domestic players. Philip Morris International (NYSE:PM) gives tobacco investors a way to remain diversified, with its operations in 180 countries around the globe, while also allowing for plenty of burgeoning growth prospects. Both India and China are offering Philip Morris an unprecedented growth opportunity as more and more citizens in those countries are moving up into a middle-class status and are able to afford the luxury of being able to purchase cigarettes. In addition, Philip Morris' risk of smoking sanctions is limited, with few of the 180 countries it operates in boasting smoking restrictions and taxes anywhere near as high as what's seen in the United States.
It could be years before we really understand the effects of mayor Bloomberg's public smoking bans, but I wouldn't be surprised to see other major cities adopt similar bans in the not-too-distant future. Domestic tobacco makers may be running on borrowed time, and investors in these companies may want to think twice about their holdings over the long term.