Altria’s Teflon or Kryptonite? Making Sense of the FDA’s Aggressive Approach to Nicotine
"Time flies over us, but leaves its shadow behind." - Nathaniel Hawthorne
Just eleven days ago I published my comprehensive work covering Altria ($MO). In it, I postulated that regulation is largely a value driver and not a value destroyer for the company. Since then, there has been a whirlwind of headlines covering regulations and rulings promising to shake up the tobacco space.
And people are losing their minds.
I am unphased, and I will walk you through why. If you’re unfamiliar, I encourage you to first review my previously written thoughts on regulation.
Let’s dive in.
The Biden administration’s plan to reduce nicotine levels in cigarettes.
Ideas of drastically reducing the nicotine in cigarettes are nothing new and trace back multiple decades. In 2018, the FDA issued an advanced notice of proposed rulemaking (ANPRM). Murmurs of a push for nicotine reduction had been floating around prior to my initial writeup, but there wasn’t much more to go off of. That changed Tuesday when the current administration published its semi-annual “unified agenda.” In it was a notice stating that the administration intends to develop and propose a rule that would set a maximum level of nicotine in cigarettes and other specified tobacco products sold in the U.S. to minimally or nonaddicted levels.
You can read the notice here.
People are getting ahead of themselves. If you look at the notice, you will see it marked as an NPRM action, a notice of proposed rulemaking. It’s worth reviewing how the full rulemaking process unfolds:
Initiating events to consider rulemaking
Optional: Advance Notice of Proposed Rulemaking
Determination whether a rule is needed
Preparation of proposed rule (Timing undefined)
Office of Management & Budget (OMB) Review
Optional: Tobacco Products Scientific Advisory Committee Review
Publication of proposed rule
Public comments on proposed rule
Preparation of final rule
OMB Review
Publication of final rule (Mandatory 1 year delay for implementation period)
Legal challenges, if deemed appropriate
The FDA stated its plans to issue the proposed rule in May 2023, but, as I’ve mentioned in my previous writing, this type of change simply isn’t something that could happen quickly. The FDA’s Center for Tobacco Products (CTP) takes a comprehensive approach to reducing the negative health effects of tobacco use with three primary focuses:
Preventing people from starting to use tobacco products
Encouraging tobacco users to quit
Reducing the harm caused by tobacco use
The FDA is prohibited from banning cigarettes or reducing nicotine levels to zero, as per S. 907d(3) of the TCA. However, it is laid out they do have the authority to control standards regarding components, ingredients, additives, and nicotine levels if deemed in the best interest of public health. Critically, final rulings must be rooted in science, and the FDA is mandated to assess the Technical Achievability and Possible Countervailing Effects of such standards. This raises a multitude of questions.
To highlight just a few:
Could reducing nicotine in cigarettes cause current smokers to smoke more to satisfy their cravings?
Would there be an increased depth of inhalation amongst smokers?
Might such a policy promote an illicit market in which full-nicotine products are smuggled in from other countries or produced domestically unlawfully?
Could reducing nicotine levels distort public perception and lead to the belief that smoking has become safer?
Would individuals be driven to manually enhance their preferred products with additional nicotine?
How would such standards impact tobacco growers?
What other economic impacts could occur?
This will ultimately result in multiple legal challenges taking place. And I can assure you there is immense opposition from numerous stakeholders, including:
Consumer tobacco product companies
Tobacco farmers
Retailers
Politicians supporting economic activity built around tobacco
Civil liberties groups
Smokers that LIKE TO SMOKE
It’s key to recognize that as the impacts of such measures would have far-reaching effects beyond the FDA’s jurisdiction, it is inevitable that other governmental bodies will likely get involved, including congress. This will further bog down the process, and could very well lead to a standstill. Additionally, a new president in 2024 could instruct the FDA to halt work on the rule entirely.
While I largely support regulation, I believe a rule to substantially reduce nicotine in tobacco products will lead to countless negative outcomes, and fortunately, is exceedingly unlikely to fully materialize.
The FDA issues MDOs to JUUL Labs
In an unconfirmed report published yesterday by the Wall Street Journal, it was announced that the FDA was readying to order Juul Labs to pull their devices off of the market; possibly as early as sometime this week.
Confirmation didn’t take long.
Today, the FDA issued marketing denial orders (MDOs) to JUUL Labs for all of their products currently marketed in the United States.
The release can be found here. It includes the following statement:
After reviewing the company’s premarket tobacco product applications (PMTAs), the FDA determined that the applications lacked sufficient evidence regarding the toxicological profile of the products to demonstrate that marketing of the products would be appropriate for the protection of the public health. In particular, some of the company’s study findings raised concerns due to insufficient and conflicting data – including regarding genotoxicity and potentially harmful chemicals leaching from the company’s proprietary e-liquid pods – that have not been adequately addressed and precluded the FDA from completing a full toxicological risk assessment of the products named in the company’s applications.
To date, the FDA has not received clinical information to suggest an immediate hazard associated with the use of the JUUL device or JUULpods. However, the MDOs issued today reflect FDA’s determination that there is insufficient evidence to assess the potential toxicological risks of using the JUUL products.
This action is somewhat surprising. JUUL’s PMTAs were thought to include some of the most robust data substantiating efficacy. On the other hand, the FDA has been eager to shut down new products since shifting its regulatory strategy. This will only continue, especially with a new CTP director taking over on July 3rd, as I mentioned prior:
Brian King, who has over twelve years of experience working at the CDC, has been selected to become the new director of The Center for Tobacco Products (CTP). Previously, he led the CDC’s evaluation of EVALI and looks partly responsible for wrongly linking the outbreak to nicotine vaping. Publicly, he remains extremely critical of new forms of nicotine products. This is the man who will be responsible for overseeing ongoing reviews of Premarket Tobacco Product Applications (PMTAs).
Today, in response to the FDA, Juul Labs released its own statement.
STATEMENT BY JUUL LABS REGARDING RECENT FDA DECISION
COMPANY NEWS
JUNE 23, 2022
We respectfully disagree with the FDA’s findings and decision and continue to believe we have provided sufficient information and data based on high-quality research to address all issues raised by the agency.
In our applications, which we submitted over two years ago, we believe that we appropriately characterized the toxicological profile of JUUL products, including comparisons to combustible cigarettes and other vapor products, and believe this data, along with the totality of the evidence, meets the statutory standard of being “appropriate for the protection of the public health.”
We intend to seek a stay and are exploring all of our options under the FDA’s regulations and the law, including appealing the decision and engaging with our regulator. We remain committed to doing all in our power to continue serving the millions of American adult smokers who have successfully used our products to transition away from combustible cigarettes, which remain available on market shelves nationwide.
— Joe Murillo, Chief Regulatory Officer at Juul Labs
What’s to make of all this? I’m left scratching my head as it seems that the FDA may have forgotten the rules of its own game.
In phase three of the PMTA process, the FDA enters Substantive Review. Along with their evaluation, they receive recommendations from the Tobacco Product Scientific Advisory Committee (TPSAC.)
The FDA’s rationale for the JUUL MDO was “insufficient evidence to assess the potential toxicological risks.” When such insufficiencies occur, the standard procedure would be for the FDA to issue a deficiency letter demanding additional information required to complete the review. Operating through this channel should remove all uncertainty when it comes time for an Action Output, i.e., a marketing granted order (MGO), or a marketing denial order (MDO.)
It’s to be expected for Juul Labs to quickly engage in the appeal process as they explore other legal avenues. And while nothing is certain, I think there is a reasonable chance they succeed in their efforts.
What does this mean for Altria?
From my previous writing:
It is essential to understand these dynamics, as tobacco and regulation will forever be intertwined. More importantly, it highlights that as society embraces continued and increased tobacco and nicotine regulation, so should Altria shareholders.
…it seems most practical to cheer for regulation that further thwarts underage access and usage of tobacco and nicotine while at the same time providing ample information, resources, and options for adult consumers to make informed choices.
The U.S. administration’s vendetta against nicotine strips millions of U.S. adult consumers of their autonomy. Removing non-tobacco flavors, and now JUUL, suggests the FDA is unserious toward its overall commitments. A superior use of resources would be prioritizing the continued adoption, as well as enforcement of, age validation technology (AVT).
If upheld, a natural result of the JUUL MDO is that some JUUL users will shift to using other electronic nicotine delivery systems (ENDS), and others will revert back to smoking cigarettes. This may, inadvertently, bolster Altria’s cigarette shipment volumes in the near future. Altria would also likely take an additional writedown on their JUUL equity stake, dropping it to below 10% of the initial $12.8 billion purchase price. This would allow them to reenter the vaping market with other owned brands.
How does this change my Altria model?
It doesn’t.
I believe continued regulation will continue to insulate Altria from new competition. In Altria’s financial reporting, they record their JUUL stake as an equity investment. In the valuation portion of my prior writing, I stated that the DCF model recognized no material value in Altria’s JUUL investment—while equity stakes in CRON and BUD were marked down by 30%, JUUL was preemptively marked down by 100%.
Through the lens of free cash flow, it looks like Altria will continue to puff along.
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Ownership Disclaimer
I own positions in $MO, as well as other tobacco companies such as British American Tobacco and Philip Morris International.
Disclaimer
This publication’s content is for entertainment and educational purposes only. I am not a licensed investment professional. Nothing produced under the Invariant brand should be thought of as investment advice. Do your own research. All content is subject to interpretation.