FDA Cigarette Proposal Tests Teflon Tobacco Stocks

(Bloomberg Gadfly) -- For decades, it seems nothing has been able to hold back the tobacco industry -- not a steady decline in U.S. smoking rates, not rising cigarette sales taxes, not even the warning labels added to packs years ago spelling out the potentially deadly effects of smoking.

That was until Friday.

A notice from the U.S. Food and Drug Administration that it plans to crack down on nicotine levels -- the very ingredient that keeps smokers loyal -- crushed all the major tobacco stocks. Altria Group Inc., the maker of Marlboro, plunged 19 percent, its biggest intraday decline in more than 17 years. Talk about a missed opportunity for short sellers, which have long ignored these purportedly incombustible stocks. 

That said, the magnitude of the selloff eased off within minutes, as analysts began to push out quick notes reiterating their bullishness.

And those analysts have a point. The tobacco giants have been preparing for this moment, even if investors didn't see it coming. 

Go to Altria's website and you'll be hard-pressed to find a picture or mention of cigarettes. It's been working with its sister company Philip Morris International Inc. (and spending big) on developing less-harmful products such as IQOS

Friday's news could present an opportunity for such reduced-risk products. That could give Altria and Philip Morris a competitive advantage over some rivals, according to Bonnie Herzog, an analyst at Wells Fargo & Co. Jefferies analyst Owen Bennett said the FDA's proposal could lead to higher sales of vapor products and more-favorable tax treatment. 

And while federal legalization of marijuana may still be years away, you can bet the tobacco giants are preparing for that day, too. As probably the most skilled industry when it comes to navigating regulation, it only makes sense tobacco would pounce on pot as a growth avenue. 

Until these next-generation smoking products become more mainstream, it's worth questioning whether tobacco stocks still deserve their premium valuations for such slow, if not uncertain, growth. Even after Friday's losses, Altria and Philip Morris both had forward price-earnings ratios of more than 20, putting them up there with the likes of Alphabet Inc. and Facebook Inc. 

One way or another, an industry investors have long been riding on autopilot may warrant closer watch. 

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

Tara Lachapelle is a Bloomberg Gadfly columnist covering deals. She previously wrote an M&A column for Bloomberg News.

To contact the author of this story: Tara Lachapelle in New York at tlachapelle@bloomberg.net.

To contact the editor responsible for this story: Mark Gongloff at mgongloff1@bloomberg.net.