Tobacco companies aren't likely to circulate through the financial media as the next major growth story. They've run the same businesses for more than a century, and have enriched their shareholders along the way.
Recently, though, the tobacco industry has begun receiving a large amount of attention for a new-product category that is proving to be extremely exciting. That product is electronic cigarettes, sales of which have boomed over the past year. Seen as a safer alternative to traditional cigarettes, e-cigs are lighting up the news headlines for their tantalizing growth potential.
But, it was only a matter of time before the government got involved. In the tobacco world, when the Food and Drug Administration comes calling, it's never good news. Unfortunately for Altria (NYSE:MO) and Lorillard (UNKNOWN:LO.DL), that's exactly what's happened.
Litigation and regulatory pose constant threats to tobacco companies. But the restrictions imposed by the FDA appear to be common-sense measures that will simply place e-cigarettes on the same playing field as traditional tobacco products. That's why it would be a mistake to get too worried about the FDA's recent involvement in the electronic cigarette market.
The FDA isn't sitting idly by
The FDA will now impose the first federal regulations on electronic cigarettes. Lorillard and Altria have a lot to lose now that the FDA revealed it's getting involved in e-cigs. When e-cigs first hit the market, they weren't subject to many of these rules because they hadn't been around long enough. As their popularity soared, concerns rose that these products were being marketed in an untruthful manner.
Consumer advocates argued that these products were just as harmful as regular cigarettes and shouldn't be marketed as a safer alternative. Moreover, because e-cigarettes came in a wide variety of flavors, it was speculated that minors were being specifically targeted. However, these concerns should abate somewhat now that the FDA has levied its ruling.
Going forward, tobacco companies will be banned from selling e-cigarette devices to minors, and makers of the devices will have to get FDA approval. In addition, manufacturers will have to disclose the chemicals used in the devices and provide health warnings that the nicotine can be addictive.
Will Lorillard and Altria get burned?
Of the two major tobacco companies engaged in e-cigarettes, Lorillard has more to lose than Altria. That's due to the significant investments it has made over the past year, and as a result, it now has greater exposure to that corner of the industry. Recall that last year, Lorillard acquired SKYCIG, a U.K.-based manufacturer of electronic cigarettes, to boost its international standing in the category. Plus, Lorillard already commands nearly half the market share in the electronic cigarette category through its Blu brand.
Altria now has its own exposure to worry about, since it recently rolled out its own e-cig product nationally. Its MarkTen product was tested in two states, and positive results prompted the company to branch out across the country. Earlier this year, Altria also acquired the e-vapor business from Green Smoke for $110 million.
The FDA ruling comes just as some tobacco companies were generating momentum. For instance, Altria recently released solid first-quarter earnings. Its adjusted earnings rose 5%, and the company boosted its 2014 forecast. For the full year, Altria expects to generate 6% to 9% growth in adjusted profits. And, management is looking forward to the national launch of the MarkTen brand in June.
Why tobacco companies won't get derailed
The potential of electronic cigarettes is the new, hot story in the tobacco industry. Sales are growing, and big tobacco companies such as Lorillard and Altria are busy building out their presence. A new set of rulings by the FDA threatens to put out the fire on that potential, but at the end of the day, there's little reason for investors to be concerned.
The rules set forth by the FDA don't represent a radical change, but rather, common-sense regulations. Although litigation risk poses a constant challenge that tobacco investors need to be aware of, these specific rules seem to place e-cigarettes simply on par with other existing tobacco products.
Altria management has the confidence to increase its full-year earnings forecast. And, soon after the FDA announcement, Lorillard issued a statement saying it actually agreed with the rulings. It's clear these management teams are still confident in their future. If you're an investor in big tobacco, you should be confident too.