Tobacco Makers Just Won a Major E-Cigarette Victory, but Does It Matter?

A U.S. House of Representatives committee recently approved an amendment to an agricultural funding bill making it easier for e-cigarettes to win regulatory clearance than current proposals from the Food and Drug Administration would allow. The FDA previously proposed that all tobacco products introduced after Feb. 15, 2007, including e-cigs and vapor products, would need to adhere to new regulatory standards if they weren't "substantially equivalent" to pre-existing tobacco products.

If such a product doesn't exist, the new offering must undergo a review under the FDA's premarket tobacco application (PMTA) process, which tobacco makers consider too strict. Vapor device makers also argue that only a single e-cigarette (which isn't a market-leading brand) was available in the U.S. prior to the FDA's cutoff date. Around 100,000 new e-cigarette and vapor products have since been introduced.

Reynolds American's Vuse e-cig. Image source: Pixabay

The House Appropriations Committee voted 31-19 in favor of "easing" that process, although it's unclear if the PMTA cutoff date would be moved or eliminated. Nonetheless, Arnaud Dumas de Rauly, treasurer of the Vapor Technology Association, told Reuters that the ruling would give the industry "a big boost of momentum". Let's see what this positive development means for the country's leading e-cig makers.

Reynolds American owns Vuse, the most popular brand of e-cigarettes in America. A Nielsen survey from January showed thatVuse controls 38.5% of the U.S. market by revenue. The brand is available at 110,000 retail outlets across the country and was one of the first e-cigs to sync with a mobile app to track usage and battery life. Reynolds nearly acquired second place Blu, which holds 20.7% of the market, through its acquisition of rival Lorillard. However, Lorillard sold Blu to Imperial Tobaccoto avoid antitrust issues.

Reynolds categorizes Vuse with its nicotine gum under its "all other" category, where sales fell 6.5% annually to $72 million last quarter. That decline wasn't surprising, since Nielsen reported that for the period ending on January 23, e-cig dollar sales fell 17.7% annually as unit sales declined 3.3%. In a research note, Wells Fargo analyst Bonnie Herzog partially attributed that decline to "difficulty in capturing SKUs of the evolving vapor category and proliferation of vapors/tanks/mods (VTM) and refills, which tend to have lower retail prices."

Easing regulations might prevent Reynolds' sales of Vuse e-cigs from being suspended for new approvals, but the overall impact won't move the needle much, since sales are declining and "all other" revenues only accounted for 2.5% of total sales last quarter.

Altria is the top tobacco company in the U.S., but it ranks fourth in the e-cig market with a 7.6% revenue share from its MarkTen and Green Smoke brands. Altria launched MarkTen in 2014, a year after Reynolds launched Vuse nationwide. To catch up to Reynolds and other market leaders, Altria acquired premiume-cigarette maker Green Smoke for $110 million in cash and up to $20 million in incentive payments. Altria also introduced new e-cig flavors and doubled its e-cig battery life with the MarkTen XL.

Like Reynolds, e-cigs only account for a tiny part of Altria's sales. Altria groups e-cigs together with snuff in its smokeless category, which posted 5.8% pre-tax sales growth last quarter. However, most of that growth was driven by sales of snuff rather than e-cigs, and the category accounted for less than 10% of Altria's top line during the quarter.

MarkTen e-cigarettes. Image source: Altria

But looking ahead, Altria might carve out a new niche market between e-cigs and traditional cigarettes with "heated tobacco products". Last July, Altria signed a dealwith its overseas counterpart, Philip Morris International , to sell its Marlboro HeatSticks domestically. HeatSticks don't produce smoke, because they are heated with an electronic device rather than burned.

More relaxed regulations will make it easier for Altria to sell both e-cigs and HeatSticks, but investors shouldn't expect sales of either product to move the needle for the company anytime soon.

The key takeawayWhile the amendment is unlikely to deliver large sales boosts to Reynolds and Altria, it does save them the trouble of sending all their e-cigarette products back to the FDA for PMTA approval. The process could reportedly cost tobacco companies millions per product, and onlya single product has passed the PMTA in the past six years. As a result, forcing nearly all e-cigs on the market through the PMTA approval track could kill the industry niche entirely, because it would be more costly to sell them than to halt production altogether.

But as I mentioned in a previous article, tobacco investors shouldn't place too much faith in the long-term growth of the e-cig market. Public bans, exploding devices, and other future regulations could also throttle demand, which currently account for a tiny percentage of industry volume.

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Leo Sun owns shares of Philip Morris International. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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