On 12 September 2018 the commissioner of the US Food and Drug Administration (FDA) Scott Gottlieb set in motion plans for
a crackdown on youth vaping.

This intervention was taken positively by investors in tobacco stocks with both British American Tobacco (BATS) and Imperial Brands (IMB) briefly rising in the aftermath – something that shareholders haven’t seen for some time as the sector has been long out of favour.

1. WHAT HAS THE FDA SAID?

Among the most powerful of US government agencies, the FDA has responsibility for monitoring the safe consumption by Americans of more than $2.4tn worth of medical products,
food and tobacco items.

Gottlieb says there is an ‘epidemic’ of younger users switching on to flavoured electronic or e-cigarettes. He’s pledged to halt sales of these types of product if major manufacturers can’t prove they are taking sufficient action to keep them out of the hands of children and teenagers.

The firms behind the Juul, Vuse (part of British American Tobacco’s portfolio), MarkTen XL, Blu (owned by Imperial Brands) and Logic brands, accounting for 97% of e-cigarette sales in the US, are being given 60 days to submit ‘robust’ plans to prevent youth vaping. If these plans aren’t seen by the FDA as having gone far enough then it could order their products off the market.

2. WHY IS IT SIGNIFICANT?

The news could act as a handbrake on an industry which has grown rapidly in recent years as it has been seen as a safer alternative to smoking tobacco. Market intelligence firm Euromonitor put global sales of e-cigarettes at £0.5bn back in 2009 but this category is now heading towards the tens of billions mark worldwide.

Unsurprisingly tobacco manufacturers have made attempts to muscle in on the action, though these so-called ‘next-generation products’ or NGPs still make a relatively limited contribution to overall sales, less than 4% for British American Tobacco in the first half of 2018, for example.

NGPs are also significantly lower margin than traditional tobacco products.

3. WHY DID SHARES IN TOBACCO COMPANIES RISE ON THE NEWS?

The key reason why traditional tobacco manufacturers saw their shares surge in response to the FDA crackdown is that the clampdown on youth vaping effectively reduces a competitive threat from Silicon Valley start-up Juul.

Juul launched in 2015 and has been a major market disruptor, taking more than 70% of the US market. The company is seen as particularly vulnerable to action from the FDA due to its popularity among younger users and emphasis on flavours.

Investment bank Jefferies says anything that slows down Juul’s market share growth is a positive for the main tobacco groups.

Liberum’s tobacco analysts comment: ‘All things equal, greater barriers to e-cigarettes are a win on the margin for (traditional) cigarettes, which are more profitable and higher ROIC (return on invested capital) for tobacco manufacturers.

‘Juul has become cool among youth in a way that few, if any, can replicate. One thing that is clear is that nicotine addicted youth will need to go somewhere to sustain their addiction. Research has shown that youth e-cig users are more likely to become smokers. As enforcement ratchets up, it will be critical to see how addicted youth respond.’

Liberum’s analysts also believe a crackdown on the use of flavours in vaping products could reduce their attractiveness and drive smokers back to traditional cigarettes.

4. WHAT HAPPENS NEXT?

It ultimately depends how firm a line the FDA takes with the industry. Pod-based e-cigarettes are also under scrutiny and Liberum notes this could be a further disappointment as they ‘were a part of the margin story for e-cigarettes’.

Using the timeline outlined by the FDA, its next move could come in mid-November. Even if this move is seen as a positive for the entrenched traditional operators in the short-term, it is worth considering the long-term implications as NGPs were seen as the industry’s main protection against stiffening global rules governing traditional cigarettes and declining levels of smoking among younger people. (TS)

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