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3 min read . Updated: 14 Aug 2021, 01:28 PM IST Tobacco giants are counting on sales of noncombustible products to replace carcinogenic smokes. Government duties will influence how quickly that happens
Cigarette companies are pouring billions of dollars into nicotine products that don’t come with the lethal health warnings of traditional smokes. New taxes risk stubbing out the returns on those investments.
Global tobacco companies’ smokeless brands are booming. For the first six months of the year, British American Tobacco and Philip Morris International reported 50% and 35% on-the-year sales growth, respectively, in their noncombustible portfolios, which include everything from oral nicotine pouches to vape pens. Altria’s Marlboro heat sticks grew 40% in the second quarter versus the comparable period last year.
To improve their standing with investors, the companies need to continue growing the share of total revenues they make from these smokeless products. Philip Morris, which makes Marlboro cigarettes outside the U.S., wants them to account for more than 50% of sales by the middle of the decade. BAT is further behind and targets roughly one-fifth in a few years.
If the shift is successful, cigarette companies should be less exposed to the risk of tighter tobacco regulations in big markets such as the European Union and U.S. Valuations could benefit. Shares in Swedish Match, a company that makes two-thirds of sales from noncombustible nicotine products, trade at a 20% premium to Philip Morris as a multiple of expected earnings.
One uncertainty is how governments will tax these new products. Philip Morris, which has spent more than $8 billion creating new brands like IQOS heated tobacco sticks, is naturally eager to ensure they aren’t treated the same way as old-school smokes.
However, the wind has blown the other way lately. In July, Germany passed legislation to raise excise taxes on heated tobacco and vapor products so that they will eventually be levied much like cigarettes. The European Union is currently overhauling its own tobacco-tax rules, which set minimum rates for member states with the aim of reducing cross-border shopping, to incorporate new nicotine products. In the U.S., Democratic legislators have launched an antitobacco bill that would put a new federal tax on e-cigarettes among other measures if it gets through Congress.
How these tax initiatives develop could have a big impact on how profitable new brands become. BAT’s vape products are still loss making. Philip Morris thinks that its heated tobacco sticks could eventually generate the same 40% operating margins as combustible cigarettes, provided it can sell enough of them.
Tobacco companies have one strong argument in their favor: Low levies help them to motivate smokers to switch to safer products. Philip Morris’s IQOS heated tobacco sticks are priced around 20% cheaper than premium cigarette brands like Marlboro.
Some countries are more reliant on tobacco taxes than others, so have more to lose by allowing smokers to switch en masse. In the US, less than 1% of government revenue comes from cigarette levies. But Australia gets close to 4% of its income from tobacco levies and Bulgaria gets 8%.
As with so much antismoking regulation in recent years, the picture won’t become clear overnight. In the EU, for instance, all member states need to unanimously agree to tax tweaks, which makes agreeing new rules a slow process. However long it takes, investors need to watch carefully. Today’s tax debate has the potential to either secure cigarette companies’ path to a healthier future or throw it into fresh doubt.
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