New Downgrade of Altria Stock Makes No Sense

By Rich Smith Markets Fool.com

Today, I've got good news and bad news for investors in Altria (NYSE: MO) stock (formerly known as Philip Morris).

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The bad news: Analysts at Germaninvestment banker Berenberg have just downgraded its rating on Altria stock to hold.

And the good news: Despite downgrading its rating, Berenberg raised Altria stock's price target $2 to $76, implying there is hope for at least a 6% profit for new Altria buyers. And when you add in Altria's 3.4% dividend yield, the potential profit rises to nearly 10%.

There's also more good news: The reasons Berenberg downgraded Altria in the first place don't make a whole lot of sense. Here are three things you need to know about this downgrade.

Will new regulations on e-cigarettes break Altria? Image source: Getty Images.

1. The "market leader" in cigarettes

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Let's begin at the beginning. As explained in a write-up on StreetInsider.com this morning, Berenberg starts out from the thesis that Altria is the "US market leader in combustible cigarettes" (aka analogs, aka real cigarettes -- the kind you light with a lighter).

That being the case, Berenberg makes the modest assertion that as the biggest seller of real cigarettes. Altria "has the most to lose from a widespread switch to vaping and/or heated tobacco products." Which makes perfect sense. If consumers switch from analogs to e-cigarettes (whether those heating tobacco, or a nicotine-laced mixture of propylene glycol and vegetable glycerine), then logically they won't be buying as many real cigarettes anymore. That would be bad for Altria's business, which depends on sales of real cigarettes to produce nearly 88% of its total revenue, according to data from S&P Global Market Intelligence.

2. A growing force in e-cigarettes

At the same time, however, Berenberg notes that Altria's "measured" entrance to the market for e-cigarettes (part of the company's 8%-of-revenue "smokeless products" division) is also bearing fruit. According to the analyst, Altria's MarkTen e-cigarette (which comprises a reusable battery paired with disposable cartridges of e-liquid) now controls about "55% of e-vapour retail volumes" in the U.S. Additionally, Berenberg notes that Altria intends to sell Philip Morris International's (NYSE: PM) iQOS tobacco-heating electronic product in the U.S. sometime early this year, after it has obtained approval from the FDA.

3. A bigger force to be reckoned with

But it's these very non-traditional-cigarette products that are what worry Berenberg. As the analyst notes, FDA approval has not yet been granted for iQOS sales. And even if it is granted, Berenberg worries that iQOS "heatsticks" will certainly be regulated as "cigarettes" under U.S. law, "and would therefore, unless definitions are altered, be liable to Federal Excise Tax (FET), State Excise Tax (SET) and Master Settlement Agreement (MSA) payments and indeed all tobacco regulations."

Additionally, and aside from the problems facing iQOS heatsticks, Berenberg notes that the FDA may decide to ban sales of e-liquids containing "fruit," "sweet," or "botanical" flavoring (to discourage their use by teenagers). Such a ban, warns Berenberg, would "severely curtail" sales of e-cigarettes in the U.S.

The most important thing: Logic

But here's the thing: Whether you're talking about nicotine ingested from dried tobacco leaves set afire, from those same leaves warmed to create an inhalable vapor, or from e-liquid heated to create a different nicotine-laced vapor -- all of these things depend on one thing: Addictive nicotine.

Addictions, by definition, must be fed in order to avoid withdrawal symptoms. Accordingly, any of the threats to Altria's burgeoning e-cigarette or iQOS businesses, if they come to pass, must logically redound to the benefit of sales of "combustible cigarettes" -- because if nicotine addicts can't get a fix one way, they're certain to get a fix another way. And as Berenberg said back at beginning, Altria remains the "US market leader in combustible cigarettes"!

Logical conclusion: Tightened regulations on e-cigarettes and similar non-traditional vehicles for nicotine delivery are not a threat to Altria's business. They're a godsend. And that's why Berenberg's downgrade of Altria stock today makes no sense at all.

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Rich Smith 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.