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The US FDA Clamps Down on the Tobacco Industry

New measures to warn consumers of the dangers of smoking are unlikely to materially impact volumes, but are a reminder of FDA’s focus on the tobacco industry

Philip Gorham, CFA 11 November, 2010 | 9:57AM
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The US Food and Drug Administration (FDA) yesterday announced new measures to warn consumers of the dangers of smoking. From October 2012, manufacturers including US-based Altria (MO), Reynolds American (RAI), Lorillard (LO), and UK-based British American Tobacco (

port/default.aspx?id=0P00007O1O&SecurityToken=0P00007O1O]3]0]E0EXG$XLON&ClientFund=0&LanguageId=en-GB&CurrencyId=GBP&UniverseId=E0EXG$XLON&BaseCurrencyId=GBP" target="_self">BATS), and Imperial Tobacco (IMT) must include graphic health warnings on packs, including images of diseased lungs. While this is likely to persuade some smokers to quit, we do not expect a material impact on volumes, and our valuation of all five firms remains unchanged. The negative impact of smoking on public health has been widely known since the Surgeon General acknowledged the link between smoking and cancer in 1964. That announcement triggered a long-term decline in demand, but almost half a century later, we think the impact of further reminders about the dangers of smoking has diminished significantly. We have analysed the impact of numerous variables on cigarette demand, and we think the most effective tool for reducing consumption is pricing. We would be more concerned about large excise tax increases than we are about today's announcement. In addition, evidence from the United Kingdom, where similar warnings have been in place for over a year, suggests that the impact of the new warnings will be minimal. Nevertheless, today's announcement is a reminder that the FDA will likely clamp down further on the tobacco industry in the medium term, and with most tobacco firms currently trading slightly above our fair value estimates, we think the market may be underestimating the industry's risks. Having said that, however, the dividend yield of around 6% on US players Altria and Reynolds is still attractive in the current low interest rate environment.

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

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Securities Mentioned in Article

Security NamePriceChange (%)Morningstar
Rating
British American Tobacco PLC2,969.00 GBX1.57Rating

About Author

Philip Gorham, CFA  Philip Gorham, CFA, is an associate director of equity research for Morningstar.

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