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Crushed by New FDA Tobacco Plan, Altria Stock Is a Buy

There's no doubt the new nicotine proposal by the U.S. Food & Drug Administration poses a substantial threat to the tobacco industry, but just as Westerners often say that the Chinese word for "crisis" means both "danger" and "opportunity," cigarette manufacturers have the chance to turn the moment to their favor.

Shares of Altria (NYSE: MO) and British American Tobacco (NYSE: BTI) were crushed after the proposal's release late last month, which should only make their stocks that much more attractive.

Image source: Getty Images.

Where there's smoke

The FDA wants to cut nicotine levels in cigarettes to the point where they are no longer addictive. The multiyear roadmap for the regulatory agency is intended to significantly reduce the number of deaths caused by smoking, and though the Family Smoking Prevention and Tobacco Control Act precludes the government from forcing tobacco companies to take their nicotine content to zero, it doesn't mean it can't make them reduce the levels substantially.

How much nicotine manufacturers would have to remove from their cigarettes to make them "non-addictive" is unknown at this point, but depending upon how low "low" is, this initiative could cause them some serious damage.

According to a paper published by the National Institutes of Health, the typical cigarette contains 10 milligrams to 15 milligrams of nicotine, and the average smoker ingests between 1 mg to 2 mg per cigarette. Because the addictive nature of nicotine is not uniform across all people, NIH estimates as little as 0.5 mg of nicotine may be required to make cigarettes non-addictive, perhaps even less, especially among children who haven't built up a tolerance to nicotine yet.

Since much of the FDA's focus is on reducing the number of under-18 smokers, the levels nicotine would need to be lowered to could be infinitesimal if the agency wanted to ensure no benefits were derived from the reinforcing effects of nicotine.

Image source: Philip Morris International.

A smokeless solution

So how would any of this be good for cigarette makers? In addition to the potential for draconian nicotine rules, the agency also extended something of an olive branch to the industry on electronic cigarettes by delaying enforcement of electronic-cigarette rules that previously would have seen the products wiped off of store shelves. Now manufacturers have until 2022 to provide information on current and future products to gain FDA approval.

FDA Commissioner Scott Gottlieb also made conciliatory comments about "encouraging innovation" that would help smokers quit smoking.

Cigarettes are a dying industry, even with some 1 billion cigarettes smoked daily. Manufacturers acknowledge their volumes are declining every year, and have been for years. Altria, for example, says its total cigarette shipment volume in the U.S. fell 2.5% last year, to approximately 122.9 billion units; Reynolds American, which is now owned by British American Tobacco, noted earlier this year that total industry domestic cigarette shipment volume fell by a like percentage, dropping from 264 billion units to 258 billion.

The companies are putting a lot of their research dollars into next-generation electronic cigarettes, and Philip Morris International (NYSE: PM) is planning for the day when the future is "smoke-free."

Image source: Getty Images.

No burning desire

While British American is the world's largest e-cig and vaping company, it's Philip Morris that has the inside track thus far on the U.S. e-cig market. It has already submitted to the FDA an application to have its iQOS device labeled as "reduced risk," a designation that if approved would give it a huge competitive advantage.

The iQOS is a heat-not-burn type of electronic cigarette. The tobacco in its cigarette-like tube, which it calls a HeatStick and will market under Altria's Marlboro brand, is heated to the point of creating a vapor that the user inhales. Since it's the smoke in combustible cigarettes that contains the toxic melange of chemicals, heat-not-burn devices promise to be a safer alternative and are seen as a viable means of getting smokers to quit smoking.

Even though Altria derives 86% of its operating income from smokeable products, its investors need to be looking to the future. And with its partnership with Philip Morris on bringing these reduced-risk products to market, Altria perhaps has the most to gain.

At just 18 times next year's earnings estimates, Altria has been discounted by the market. Plus its dividend of $2.44 per share yields an attractive 3.4%, making it a stock investors should be considering closely.

There could be some significant short-term pain, should the FDA proposal be draconian. But because it's still all conjecture, the electronic-cigarette side of the equation even gives Altria and Philip Morris some unique competitive advantages.

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Rich Duprey has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.