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Daily Intelligence Briefing

Tuesday, July 20, 2021

Identifying Change-Driven Investment Themes – Five sections, explained here.

The Daily Intelligence Briefing is published by McAlinden Research Partners. The report is provided to Hedge Connection blog readers once per week for free. Below is just one of the five sections that delivers Change-Driven Investment Themes everyday.

I. Today’s Thematic Investment Idea

A deep dive into a market driver with alpha generating potential.

Altria and Philip Morris’s Diversification Strategies Decouple as Big Tobacco Faces Uncertain Future

Summary: Big tobacco distributors Altria and Philip Morris are spending billions on smokeless alternatives to the cigarettes that have driven their business model for decades. Though the decline in US cigarette sales halted in 2020, that deviation was likely a short-lived, pandemic-driven reprieve from the dominant downward trajectory that is expected to continue driving the American cigarette market lower in coming years.

For Altria, their big bet on Juul Labs has been characterized by constant regulatory scrutiny, driving the e-cig maker from a valuation of $35 billion to less than $5 billion. All hope is not lost for the Altria-Juul partnership yet, but its future now rides on an upcoming decision by the FDA, as well as an FTC antitrust case.

Related Stocks: Altria Group, Inc. (MO), Philip Morris International Inc. (PM)

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In 2020, US cigarette sales halted a long-term decline in sales. In 2019, for example, Forbes notes that cigarette sales dropped 5.5%, but the onset of the pandemic likely played a significant role in 2020’s sales figures that were just about equal to the previous year.

That wasn’t a huge cause for celebration among big tobacco distributors like Altria, owner of Marlboro, or Philip Morris, the largest global tobacco conglomerate by revenue, who are likely aware that the cigarette market is still ultimately on a trajectory toward demise in several developed nations.

While Altria has tried its hand at diversification over the last few years, its biggest investment – a $12.8 billion spend for a 35% stake in e-cig darling Juul Labs (which once controlled almost three quarters of the entire e-cig market) in December 2018 – has run into roadblock after roadblock. As of September 2020, Altria valued its stake in Juul at just $1.6 billion, following a decline in the e-cig maker’s valuation from a peak of $35 billion to less than $5 billion.

Philip Morris has had much better luck in their own pursuits. In particular, its IQOS device (an abbreviation of “I Quit Original Smoking), their response decline of smoking and ascent of vaping. As MRP has previously noted, IQOS serves as a device in the middle that heats tobacco, but doesn’t burn it, designed to give users the same rush of nicotine as smoking with fewer toxins. Vaping, by contrast, involves heating a liquid that often contains synthetic nicotine, among other substances, not tobacco itself. According to the company, heating tobacco at 350 degrees Celsius (662 degrees Fahrenheit) lowers the release of harmful chemicals such as benzene, arsenic and formaldehyde by an average of 95%.

As the Motley Fool reports, Philip Morris has already declared the future to be “smoke-free”, launching its Beyond Nicotine initiative in February, planning to generate over half of its total net revenue from smoke-free products by 2025, and at least $1 billion from products “beyond nicotine”. That preceded the company’s recent acquisitions of nicotine gum maker Fertin Pharma from private equity firm EQT for $813.1 million, as well as drugmaker Vectura, manufacturer of respiratory ailment treatments and inhaling device technology, for $1.44 billion.

In late 2019, a planned mega-merger between Philip Morris International and Altria, worth $200 billion fell apart after US Food and Drug Administration (FDA) scrutiny whacked the ascendant Juul brand. Philip Morris was supposed to be Juul’s pipeline to critical foreign markets since PM has been the dominant player in international sales over the last decade. Since the dissolution of merger plans, the Altria-Juul partnership has suffered a multi-year spate of setbacks.

Altria’s Vaping Venture Continues to Crack

MRP has covered the FDA crackdown on Juul for nearly two years now, after the company was accused of illegally marketing their products with false, unsubstantiated claims about their vaporizers’ effect on user health. In March of that same year, convenience stores and gas stations were effectively banned from selling most flavored e-cigarettes by the FDA, following concerns about teens acquiring e-cigarettes at such locations. FDA accusations against Juul came amid an outbreak of more than 2,700 cases of a mysterious lung disease, called e-cigarette, or vaping, product use associated lung injury (EVALI), caused by the use of e-cigs that killed at least 60 in the 2019-2020 period.

Though the outbreak in illnesses was ultimately pinpointed to improper use of vaporizers, particularly via illicit vitamin E acetate, the presence of e-cig devices is still the delivery mechanism used.

Juul’s corporate crisis came to a head when the Trump Administration slapped the vaping industry with a ban on all flavored e-cig and vaping cartridges. Juul had already preemptively removed those flavors from distribution, but the ban showed that the vaping industry as a whole was going to have to spend years fighting for legitimacy.

Fast forward to 2021 and, as the New York Times notes, Juul is now the subject of thousands of lawsuits as sales have plunged by $500 million, market share is now below 50%, and the company’s workforce is just a quarter of what it was at its peak. Even Altria’s deal to secure a chunk of Juul’s business is now under antitrust scrutiny as the Federal Trade Commission (FTC) alleges the cigarette maker engaged in anticompetitive practices ahead of its 2018 investment in Juul. As the Wall Street Journal notes, that case, which has the potential to completely unwind Altria’s position in Juul, went to court earlier this month.

To their credit, Futurism has reported that Juul plans to fight back against underage vaping by age-restricting its vapes via Bluetooth tech that won’t let customers take a hit until they’ve uploaded their government-issued ID.

Upcoming FDA Decision Could Rupture or Revive Juul

By September 9, the FDA is set to decide whether Juul’s devices and nicotine pods have enough public health benefit as a safer alternative for smokers to stay on the market.

Some could argue that Juul has a case. As the Wall Street Journal notes, consumers and industry officials admit some e-cigarette users turned back to combustible cigarettes because of increased e-cigarette taxes, bans on flavored vaping products and confusion about the health effects of vaping.

A study from the Yale School of Public Health (YSPH), published in JAMA Pediatrics last May, found San Francisco’s 2018 ban on the sale of flavored tobacco products may have actually increased rates of smoking among teens. Analyses found that, after the ban’s implementation, high school students’ odds of smoking conventional cigarettes doubled in San Francisco’s school district relative to trends in districts without the ban, even when adjusting for individual demographics and other tobacco policies.

A separate study out of Queen Mary University of London, published in Addiction and funded by top cancer researchers in the UK, has determined that vaping can be “more effective” than patches, gum and other nicotine replacement products for quitting. As the New York Post highlights, 27% of the study’s participants in the e-cigarette group had reduced their smoking habit by at least half, and another 19% had successfully quit altogether (confirmed with a carbon monoxide breathalyzer reading). Only 3% in the control group quit cigarettes and 6% managed to cut back. 135 smokers participated in the study.

While those form a good argument for vaping’s ability to help prevent or quit smoking, the more important issue at hand is whether vaping is indeed a safer alternative.

It’s hard to make a case either way since vaping is still relatively new and little long-term data on e-cig users exists. However, a 2020 study by Northwestern University researchers found 33% of 1,400 e-cigarette users reported having one or more of the five symptoms associated with EVALI. These symptoms include cough, shortness of breath, nausea, stomach pain and chest pain.

Juul certainly didn’t help its credibility or public image when the company paid the American Journal of Health Behavior $51,000 to fill the entire May/June issue with 11 studies funded by the company. As VICE reports, the research conclusively found that vaping is a public health benefit. Juul’s financial arrangement with the journal does not necessarily mean the studies are without merit, but it did result in the resignation of three editorial board members and prompted wide-spread accusations of Juul attempting to pad the scientific record.

It remains to be seen what the future looks like for big tobacco’s pursuit of smoke-free alternatives, but a lot is certainly riding on the fate of Juul – which could ultimately be settled at some time within the next 7 weeks.


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