Analysts see positives for tobacco in US e-cigs crackdown

US regulators' warning to electronic cigarette companies about combatting the rising use among youth held "positives" for big cigarette companies such as British American Tobacco and Imperial Brands, said analysts at UBS, Jefferies and Liberum on Thursday.

A day earlier, the US Food & Drug Administration warned of the growing "epidemic" among teens and said the "accelerating trajectory of use...must end", saying it was an unacceptable tradeoff that unfettered access for adults of ecigarettes was resulting in generation of young people potentially becoming addicted to nicotine.

Privately owned Juul has materially grown, with a remarkable 72% market share and penetration of 3% of the total tobacco/nicotine market, with British American's Vuse, Altria's MarkTen, Imperial Tobacco's blu and Japan Tobacco's Logic are all subject to the same scrutiny.

The FDA has written to the manufacturers, which have 90 days to respond with "robust plans on how they'll convincingly address the widespread use of their products by minors" or else the agency has threatened to outright remove all or some of the product variants from the market.

Regulators are also undertaking a general review of the law, including investigating whether certain products were introduced to the market after the deeming rule took effect in August 2016).

"All things equal," wrote Liberum's analysts, "greater barriers to e-cigarette are a win on the margin for cigarettes," which are more profitable and generate higher return on invested capital for tobacco manufacturers. UBS agreed that "further regulatory scrutiny as positive news for tobacco company valuations".

Jefferies said: "Anything that slows down Juul market share is a positive and this is what we think we will see in all possible outcomes around the '60 day' action. Very best case is Juul flavours are removed from the market and the majors remain. Next best case is all flavoured products are removed from the market. For us, also a positive.

"While all names would take a volume hit, the biggest impact is likely to be on Juul, and it may also mean for the time being focus goes back to the old model of just cigarettes (and smokeless) which is perfectly robust still (a point that is often overlooked or misunderstood with all this Juul paranoia)."

The FDA's crackdown, which it called the largest coordinated tobacco compliance effort in its history, has seen more than 1,100 warning letters were sent to stores for the illegal sale of e-cigarattes to minors and 131 civil money penalties to stores that violate the restrictions on sales to minors.

Liberum said Juul "has become cool among youth in a way that few, if any, can replicate", but nicotine-addicted young people may "need to go somewhere to sustain their addiction".

The FDA has identified that some flavours are more 'kid-appealing' than others and are evaluating "the availability of characterizing flavors", which analysts suggested could mean the practical challenges of drawing the lines of flavour category.

US regulators also hinted at problems with pod-based e-cigs, which are higher margin due to the razor and blade model, which are easier to hide from parents/school administrators. "We see this commentary as a negative for the tobacco industry as it tends to struggle with open tank (mods)."

UBS noted that tobacco companies have "consistently argued for a more closely regulated nicotine market in the US in order to, among other things, prevent sale to underage consumers and ensure a minimum product/ingredient safety".

The bank's analysts said that a significant portion of the 12-month de-rating in the tobacco sector is likely to be down to fears that JUUL had proved barriers to entry were much lower in the next generation product market. "In our view this should go some way to reassuring investors that this is not the case."

Jefferies felt that without the support of youth, Juul will be going head-to-head with big tobacco to capture adult smokers and would find it difficult to compete in the traditional distribution channels, as majors dominate the space and have power of retailers with regards to shelf space.