Will Tobacco Troubles Really Char Staples ETFs' Safety?

On July 28, the U.S. Food and Drug Administration (FDA) proposed to reduce nicotine levels in cigarettes to non-addictive or minimally addictive levels, due to its perilous effects on health. Since, FDA’s regulation is aimed at the addictive nature of cigarettes, the latest restriction could lower cigarette consumption and the profitability of tobacco companies.

In any case, governments around the world have been proactive in applying restrictive enforcements on tobacco companies. For example, the FDA made it compulsory for all tobacco makers to seek marketing approval for any tobacco product introduced after February 15, 2007. Moreover, the European Union and the FDA have proposed a ban on menthol in accordance with the Tobacco Control Act.

Following the proposal in late July, stocks of cigarette makers including Altria Group (NYSE:MO) MO , British American Tobacco (LON:BATS) Plc (NYSE:BTI) , Philip Morris International Inc. (NYSE:PM) and Vector Group Ltd. (NYSE:VGR) fell. However, Philip Morris shares were less hurt in the lot. Most of the stocks were in the red in the last five days (as of August 3, 2017) with MO, BTI, PM and VGR sliding about 11.4%, 6.7%, 3.1% and 6.8%, respectively.

Tobacco’s ETF Exposure

Two tobacco companies – Altria and Philip Morris – has huge exposure to consumer staples ETFs. Consumer Staples Select Sector SPDR Fund XLP, Fidelity MSCI Consumer Staples Index ETF (LON:FSTA) and Vanguard Consumer Staples ETF VDC invest about 8-10% of their holdings in Philip Morris (read: ETFs in Focus After Phillip Morris's Downbeat Q2 Results).

In fact, the three ETFs have about 17-20% of their exposure targeted at the tobacco industry. On the other hand, Altria has considerable exposure to FSTA, iShares Edge MSCI USA Quality Factor ETF QUAL,XLP, VDC and iShares U.S. Consumer Goods ETF IYK. These funds put about 5-6.5% of their assets in Altria (read: Time to Cash in on Cola Earnings with These ETFs?).

Vector Group has an exposure of about 1.5-3.5% to PowerShares High Yield Equity Dividend Achievers Portfolio ETF (TO:PEY) and WisdomTree SmallCap Dividend Fund (MNE:DES) .

BTI is invested about 3.5% to 4.3% in ETFs like BLDRS Europe Select ADR Index Fund ADRU and BLDRS Developed Markets 100 ADR Index Fund ADRD.

Are Staples ETFs Really in Trouble Over the Long Run?

Most of the above-mentioned ETFs lost in the last five days (as of August 4, 2017). Normally, staple ETFs are known for safety due to their non-cyclical business pattern. However, if tobacco companies continue to get hurt like this, consumer staples’ ETFs may see some troubles (read: Tough Time Ahead for Grocery Stocks and ETFs?).

Investors should note that these tobacco stocks offer decent levels of dividend too with Altria and Phillip Morris offering 3.72% and 3.63% yields (as of August 3, 2017). So, investors’ quest for dividend will also likely get burnt in tobacco woes.

But there is a bright side as well. Research house Cowen “does not expect regulatory changes to put tobacco company earnings at risk until at least 2019” as the FDA process is likely to be slow. The FDA is likely to be “considering a delay in implementing new rules for reduced-risk products like e-cigarettes.”

As per Cowen, companies like Philip Morris and Turning Point Brands will actually benefit from the FDA’s move as these are well positioned to boost their e-cigarette businesses. However, not all players are shielded, so, over the long term, the impact is likely to be mixed.

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