If you don’t keep an eye on tobacco companies, you might not notice this new situation. On Tuesday, Philip Morris International announced it would invest $600 million to build a new manufacturing facility in Colorado for its popular Zyn oral nicotine pouches, a product that caused a social media buzz earlier this year and is now in short supply nationwide due to capacity constraints. The news came on the heels of Reynolds American, a subsidiary of British American Tobacco, unveiling a new flavored vaping product, Sensa, that doesn’t contain nicotine, earlier this month. These products are just two of many aimed at capturing current and former smokers and replacing lost cigarette sales. Alternatives include heat-not-burn and nicotine e-cigarette products, the latter of which tobacco companies face stiff competition from e-cigarette companies and the proliferation of illegal e-cigarettes. “When you look across the consumer spectrum, people are changing the way they consume and the products they use,” said Brett Cooper. “Tobacco products tend to evolve a little slower, but that’s part of a larger mosaic of changing consumer wants.” Fighting for a decline in tobacco use is nothing new for big tobacco companies. Philip Morris, for example, said its cigarette shipments fell from 915 billion cigarettes in 2011 to 613 billion in 2023, continuing a downward trend every year for the past decade. PM 1Y mountain Philip Morris’s performance over the course of a year Countries around the world have been working to reduce tobacco use for years. In 2013, the World Health Organization set a voluntary goal of a 30% relative reduction in tobacco use by 2025. By 2022, the projected relative reduction is 24.9%, the organization said in a report earlier this year. Philip Morris plans to eventually replace cigarettes with smoke-free alternatives. The company announced in its 2023 investor briefing in September that it aims to get more than two-thirds of its net revenue from smokeless products by 2030. “I’m not saying that in 10 or 20 years, flammable products will be nowhere to be found, but it’s almost certain that smokeless products will be gone. [is] “It’s going to grow. There’s no going back,” Philip Morris Chief Financial Officer Emmanuel Babaud said at a Deutsche Bank conference in June. What investors are watching and watching is whether tobacco companies can effectively make up for the revenue they ultimately lose from cigarettes by moving to reduced-risk products, or RRPs. The Allure of Dividends Still, many investors who buy tobacco stocks are drawn to attractive dividends. For example, Philip Morris’ dividend yield is 4.84%, Altria’s is 7.95% and British American Tobacco’s is 8.87%. Analysts don’t think those dividends are going away anytime soon. Jefferies analyst Owen Bennett thinks the switch to RRPs will allow the companies to maintain their dividends, although some are better off than others. Cooper agrees.[Philip Morris International is] “Given that the path to substitution is well advanced and substitution is more profitable for PM than its core business, I don’t see any risk to the dividend or dividend growth,” he said. Philip Morris USA parent company Altria may not be as advanced as its competitors, but there is still room to continue paying dividends at this level or even higher, he added. Smokeless products overcoming bans and illegal competition are not without their critics. WHO’s campaign targets both smoked and smokeless tobacco. The organization also urges the government to apply the same tobacco control measures to nicotine vapes, saying there is “alarming” evidence of their negative effects. There is also concern about the popularity of vapes (also known as e-cigarettes) among underage consumers who are attracted to flavors. According to the Centers for Disease Control, 4.6% of middle school students and 10% of high school students in the United States will use vapes by 2023. The Food and Drug Administration has consistently refused to approve flavored vapes and banned the sale of e-cigarettes that it does not approve. But experts say enforcement is difficult. States are following suit, with varying degrees of success. In July, the U.S. Supreme Court agreed to consider a challenge brought by e-cigarette makers to the FDA’s refusal to approve flavored vapes. These flavors include pistachio, pineapple, and blueberry. One of the flavors allowed by the FDA was menthol, which gave its first approval to menthol e-cigarettes in June. The FDA also lifted its 2022 ban on Juul e-cigarettes that same month while it considers updated information and new court rulings. Vapes, which emerged in the mid-2000s and surged in popularity, remain a popular product. Global vape retail sales will grow 54% to $35 billion in 2023, according to estimates from UBS’s proprietary model. Most of that will come from Chinese companies, with tobacco companies accounting for only about a 15% share, the bank said. “The WHO has also ordered ’emergency measures’ to regulate e-cigarettes. However, (i) bans have been largely ineffective and have created a gray/illicit market, (ii) Chinese manufacturers have successfully circumvented the regulations, and (iii) enforcement has been complex (e.g., illicit/illicit tobacco trade is on the rise),” UBS analyst Faham Baig wrote in a June 14 note. Will tobacco stocks recover? There’s no doubt that the popularity of e-cigarettes has accelerated the rate of decline in cigarette sales. Some tobacco companies have their own e-cigarette products and are trying to make inroads in the market, while others are focusing on other areas. “Companies are doing everything they can to stay in business,” said Dan Arends, chief operating officer of AdvisorShares and author of the 2004 book Investing in Vice. One of the firm’s exchange-traded funds, Vice, typically invests in alcohol, gambling, video games, fast-casual restaurants and tobacco stocks. “They’re increasing their exposure to lower-risk products, but it’s a slow move,” Arends said. “There’s no denying that the largest percentage of revenue is still tobacco, but it’s a market that’s slowly declining.” He hasn’t been overweighting tobacco stocks lately, but he has a small position in British American Tobacco and a large position in small-cap Turning Point Brands because he expects growth to moderate. Philip Morris International is one of Wall Street’s favorites. The stock has an average rating of overweight, according to FactSet, with about 5% upside potential relative to its average price target. Cooper of Consumer Edge and Bennett of Jefferies are both bullish. Cooper rates it overweight, while Bennett rates it buy. Philip Morris is making big bets on its modern oral product, Zyn, as well as its heated tobacco product, Iqos, and its vape product, Veev One. The company beat expectations on both first-quarter profit and sales, although second-quarter earnings are due to be released on Tuesday. Overall, the smokeless business accounted for 39% of total net sales in the first quarter. Sales of Iquos products, which first launched in Japan in 2014, rose 20.9% year-over-year to 31.1 billion units in the quarter. Iquos is expected to gradually begin appearing on shelves in some U.S. states. Heat-not-burn tobacco products have not encountered the same regulatory hurdles that vape products have faced, making them very profitable for Philip Morris, Bennett said. Meanwhile, Zyn nicotine pouches rose 35.8% to 4.2 billion units. The growth was fueled by its popularity in the U.S., where shipments increased 79.7% year-over-year. “There’s a lot of room for growth in Zyn and nicotine pouches,” Cooper said. “There’s a pretty big difference in the development of the segment across states and regions, but I think this shows that there’s an opportunity if the product gains more traction and the levels of consumer use and word of mouth increase.” The new facility in Colorado, coupled with an expansion already underway in Kentucky, should ensure Zyn supplies are more than adequate going forward, Bennett said. He estimates that the combined capacity of both facilities could reach up to 2.5 billion cans. Altria, which was spun off from Philip Morris International in 2008, has a 2% downside risk to analysts’ average price target at Hold. Under the separation agreement, Altria will sell cigarette brands such as Marlboro in the United States, while Philip Morris will sell them outside the United States. Altria’s One-Year Performance Cooper gives the stock an equal weight rating because Altria is in the early stages of its path to replacement. Bennett, however, rates Altria a Buy. The company acquired NJoy, which makes nicotine-containing e-cigarette products, last year. In April, the company reported that NJoy’s retail share in the first quarter was 4.3%, up 0.6 percentage points from the fourth quarter. Altria has been fighting illegal e-cigarettes. The company filed a lawsuit in October against 34 domestic and foreign manufacturers, distributors and online retailers that make illegal e-cigarette products. “There are two markets out there right now: one that follows the rules, and one that blatantly ignores them. We are taking this action because the status quo of the illegal e-cigarette market is unacceptable. Further action is needed from the FDA and others,” Murray Garnick, the company’s executive vice president and general counsel, said in a statement. Altria is scheduled to report its second-quarter earnings on July 31. Finally, British American Tobacco has an average rating of Overweight, 17% above the average analyst target price, according to FactSet. Bennett is among those recommending the company as a Buy. The London-based company has products in the vapor, heat-not-burn and modern oral categories. BTI 1Y Mountain British American Tobacco 1-Year Results Bennett is bullish on the company’s latest nicotine-free vape, Sensa. He believes the company’s sales volume can be supported by retaining consumers who want to quit nicotine altogether, or by attracting new customers who like flavor but don’t want nicotine. Moreover, it could pave the way for expansion into other areas such as caffeine, vitamins and melatonin, he said. “BAT is making a strong case for going ‘beyond nicotine,'” Bennett wrote in a July 1 note. “This could include using oral and vaporization technologies to administer other active ingredients.” Eventually, it could also include generics, he added. Ultimately, Bennett believes the key to a revaluation of tobacco stocks will depend on how well they capitalize on these new products. He thinks that could happen. The first phase of this valuation reset will happen when the market starts to gain confidence in RRPs, and the second phase will happen when investors realize that the decline in sales volumes during the transition is not as pronounced as feared, he said. The third phase of growth would come if the company goes beyond nicotine, he added. “I see significant upside there,” Bennett said.
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Sunday, December 22
Big Tobacco ramps up alternatives. Here’s who could come out on top
By u1news-staff
