The bad news just doesn’t stop for Big Tobacco. The industry is no stranger to smoking bans, punitive taxation, and crippling lawsuits, particularly in the United States. But life continues to get more difficult in much of the rest of the developed world too. Let’s take a look at new developments coming out of the UK.
In June, the British Medical Association (“BMA”) voted in favor of banning cigarette sales to anyone born after 2000. The BMA is a doctors’ union, not an arm of the government, so its proposed ban has no legal teeth to it. But this is the same BMA that successfully lobbied the British government to ban smoking in public places. The UK’s Health Act of 2006, supported by the BMA, made smoking illegal in all government buildings, workplaces, and restaurants.
Whether the ban on British would-be future smokers passes or not, the handwriting is on the wall. Western governments, saddled with unaffordable health costs, will not be letting up the pressure on Big Tobacco any time soon. And it’s starting to show up in earnings reports. Last week, Philip Morris International Inc (NYSE:PM) trimmed its earnings outlook for 2014, citing, among other factors, one of the most potentially devastating regulatory developments in decades: Australia’s plain packaging rules, which require all cigarettes, regardless of brand, to be sold in plain, white boxes with standardized font on one side…and a picture of a person dying of cancer on the other.
I wrote about Australia’s new rules a year ago (see “Judge Tobacco Stocks by Their Cover”), predicting that they would be very damaging to Big Tobacco’s branding power. As I wrote then,
Longtime chain smokers light up for one very obvious reason: They are addicted to the nicotine. But for casual smokers — those who light up while drinking, for example — the experience matters, too.
I call it the “Rebel Without a Cause effect” … the devil-may-care image that goes along with smoking is part of what makes it pleasurable.
There is a certain appeal to Altria's (NYSE:MO) familiar Marlboro logo. But there is most certainly no romance in a plain white box with a picture of a diseased lung on the flip-side.
Sure enough, Philip Morris CEO Andre Calantzopoulos noted that the rules were having an ill effect on Australian sales: “With plain packaging, adult smokers do not quit more or smoke less. They do, however, appear to down-trade much more readily to lower price, lower margin brands and illicit products.”
The UK and Ireland are also seriously considering plain packaging laws, and several other countries are reported to at least be toying with the idea.
Even “vaping,” or the smoking of e-cigarettes, is under attack. The U.S. Food and Drug Administration announced in April that it would be begin regulating electronic cigarettes. And overseas, Britain’s equivalent of the FDA will begin regulating e-cigs as of 2016. E-cigarettes—which are safer than traditional cigarettes because of the absence of carcinogenic tar—are actually illegal in Brazil, Norway and Singapore.
Remember, e-cigs were supposed to “relight” Big Tobacco as the transformative product that saved the industry from secular decline. So much for that idea.
Where does Big Tobacco go from here?
I’m not predicting wholesale bankruptcy any time soon, and in fact, I still own shares of PM and MO in a few dividend-focused portfolios I run. But I believe it’s important to be realistic here. The industry’s ace in the hole—rising demand overseas to offset long-term decline in the developed world — is looking less and less reliable. Even China—the world’s largest tobacco user by a wide margin — moved to ban indoor public smoking earlier this year. It is only a matter of time before the regulatory vice is tightened further.
If you own tobacco stocks as part of a diversified dividend portfolio, I think it’s fine to continue holding your positions and to reinvest the dividends. But I wouldn’t put significant new money into Big Tobacco any time soon, or at least not at today’s prices. PM and MO trade for 16 and 19 times earnings, respectively, compared to an P/E of about 20 for the S&P 500. Given the lousy growth prospects and the virtual guarantee of continued regulatory attacks, I would only recommend making new purchases of Big Tobacco stocks at much wider discounts to the market.
This article first appeared on InvestorPlace.
Charles Lewis Sizemore, CFA, is the editor of Macro Trend Investor and chief investment officer of the investment firm Sizemore Capital Management.