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Cynicism and Big Tobacco
April 22, 2008; Page A24
Congress wants to give regulators more authority over the tobacco industry – so what else is new? The surprise is that currently there are no plans to give it to the Environmental Protection Agency. Surely cigarette smoke qualifies as a dangerous pollutant.
Not that Congress needs any ideas, but handing off tobacco to the EPA makes about as much sense as its nearly completed pass to the Food and Drug Administration. A bill expected to be voted on soon would impose new restrictions on marketing, raise cigarette taxes, and police the ingredients in tobacco products, including nicotine levels. Any reckless FDA policy is bound to be popular, and sure enough, the bill has 220 co-sponsors in the House and 54 in the Senate, including all three Presidential contenders.
This is all phenomenally cynical, even for Congress. Since the 1964 Surgeon General's report, the health consequences of this hazardous if legal product have been ubiquitous, which no doubt accounts for the 58% plunge in smoking among U.S. adults. The FDA tobacco gambit is explainable only because the politicians have dumped public health for public revenue.
The 1998 litigation settlement between 46 states and the industry was supposed to recoup the Medicaid costs of treating sick smokers, but the $150 billion payout was promptly redirected to other political priorities. The feds joined in the shakedown, building a $280 billion racketeering case that resulted in a mere $10 billion in 2006. Government has also bought a stake in lucrative tobacco profits by using cigarette taxes as the first-resort fundraiser for new domestic programs, most recently last fall's abortive Schip expansion.
The FDA bill would further prop up this tobacco-politician partnership, by prohibiting the agency from banning tobacco products, and – to buy the support of Big Tobacco – by creating protections against smaller competitors. Existing products would be grandfathered in, but new ones would be subject to premarket approval and advertising curbs, effectively freezing the market. The industry would also be relieved from further lawsuits, since it could claim compliance with FDA product-safety scrutiny. Philip Morris, maker of the No. 1 Marlboro brand and the world's largest tobacco company, is understandably thrilled by the proposal.
The FDA is not as lucky. The agency is barely capable of managing its existing workload, which includes responsibility for about 25 cents out of every dollar spent in the U.S. FDA Commissioner Andrew von Eschenbach told Congress in October that the $5 billion in "user fees" over the next decade wasn't enough to kickstart a tobacco division and that the FDA "may have to divert funds from its other programs."
The FDA's own advisory panels say it lacks the expertise and resources to keep pace with scientific advances. So of course it makes sense that the agency will continue to do more things badly instead of a few priorities well. And as if the FDA wasn't already hypersensitive to political pressure, now it will take over a political motherlode.
Mr. von Eschenbach also pointed out that the legislation actively undermines his core mission, which is to promote public health. FDA regulations are devised to prove that medical therapies are safe and effective. When used as directed, cigarettes produce disease. The logical response – if the FDA is going to be implicated in what ought to be a matter of individual responsibility – should be to remove cigarettes from the market.
But since Capitol Hill has cut itself in on the business, Congress will instead apply every other regulation for pharmaceuticals and medical devices short of prohibition to new tobacco products. For instance, only "modified risk" cigarettes will be allowed onto the market. Manufacturers will have to prove not that they are "safe," but that they are less likely to lead to lung cancer, emphysema, etc., requiring long-range randomized clinical trials. In the absence of any therapeutic benefits from smoking, this is unethical, not to mention unscientific.
All the more so because it contradicts the premise of the federal government's case against Big Tobacco. Initiated by Janet Reno and continued by the Bush Administration, the federal suit argued that the industry committed fraud by falsely implying that light or low-tar cigarettes were healthier than standard smokes. Now Congress wants the FDA to mandate less nicotine and tar – the very practices it once claimed to find so odious.
In a final irony, the politicians backing this bill, especially sponsors Ted Kennedy and Henry Waxman, are the same ones demanding that the FDA crack down on "Big Pharma." They say it isn't doing enough to protect the public from risky but possibly beneficial new drugs. So: Lend the FDA imprimatur to an inherently dangerous product to fatten it up for taxation, while at the same time slow down or block the approval of life-saving therapies that treat disease instead of cause it. Congressional priorities are rarely so grotesque.
smile
RealMoney by TheStreet.com
PMI Could Catch Fire
Friday April 18, 8:59 am ET
ByCharles L. Norton, RealMoney.com Contributor
It was back in 2004 that Louis Camilleri, then head honcho of Altria , first mentioned his dream to one day separate the company's two tobacco units, Philip Morris USA and Philip Morris International . It took almost four years, but it's now complete. And while I still like Altria, PMI should be able to capture worldwide growth in tobacco products.
The new Altria -- consisting essentially of Philip Morris USA plus a large stake in SABMiller, the world's third-largest brewer -- is the leader in one of the most profitable cigarette markets in the world.
Granted, cigarette volumes in the U.S. have been in a secular tailspin for years, and future tax hikes could further exacerbate the drop. But Altria -- along with its peers -- enjoys strong pricing power that has thus far been able to largely offset that. Management has committed to cutting costs, and even more can (and should) be done on that front.
The company's strong, premium-focused portfolio generates significant cash flow, much of which will end up getting directed back into the pockets of shareholders through a pretty juicy dividend yield that's north of 5%.
And then there's that radically underleveraged balance sheet that will finally be utilized to repurchase stock. All told, more than $12 billion will be returned to shareholders over the next two years through a combination of dividends and stock buybacks.
All of this is against a legal backdrop that's now largely benign. Indeed, especially in light of the favorable ruling in the Schwab case a few weeks ago that put the kibosh on the industry's last sizeable remaining legal threat, the U.S. cigarette manufacturers are enjoying a legal environment that's as favorable as it's been in a decade or more.
Of course, legal threats could resurface, though that's unlikely. More possible: A material increase in state or federal excise taxes could kick industry volumes while they're down and consequently reduce cigarette makers' operating leverage. Also, though less important, there is a question mark around the company's moist smokeless tobacco test going on in Atlanta and the future success of a Marlboro-branded snuff product.
But I think the biggest risk to Altria, really, is the guy in the corner office and those in the board room.
Now, with the long-awaited Kraft and Philip Morris International spinoffs complete and a commitment to buy back stock made, a seemingly passive management team with a "job is done" attitude might not be forceful enough in continuing to push all the value-creating buttons it has available.
I would like to see significant further cost-cutting measures, a monetization of its SABMiller stake -- now substantial in weight relative to the smaller size of the company -- and more aggressive stock repurchases through an even greater use of its balance sheet. But, in the near term at least, I don't expect we'll see much.
That said, I like Altria as a cost-cutting, balance-sheet-releveraging, stock-buyback story with a nice dividend that's operating in a pretty favorable environment, though I prefer Carolina Group among U.S.-centric tobacco companies.
But the U.S. cigarette market differs substantially from that of international markets. While the U.S. cigarette industry has been plagued by declining consumption trends, internationally there are real growth opportunities. And no company has more going for it than Philip Morris International.
PMI's products are sold in around 160 countries; it holds the No. 1 or No. 2 market share position in many of them. With broad geographic diversification, the company has limited regulatory or legislative risk tied to any single market. That said, litigation risk is insignificant and governments are becoming fairer and less onerous in their taxation.
All told, it owns 15.4% of the international cigarette market, making it the industry leader (China's state-owned tobacco company aside). And while that's impressive, it's quite modest relative to its sibling's 50%-plus market share ownership of the U.S. market. There's certainly an opportunity to snag volume from its competitors and increase its market penetration.
The biggest long-term growth driver, bar none, is the development of PMI's relationship with the state-owned China National Tobacco Corporation, or CNTC.
China is far and away the world's largest cigarette market, with an estimated 350 million smokers and annual volumes exceeding 2 trillion cigarettes, a third of the world's volume.
It's been over two years since PMI and CNTC entered into an agreement to make and distribute Marlboros throughout this highly profitable market, and nothing has come of it yet. But it's just a matter of time. Longer term, PMI has the potential to develop a significant business in China and dramatically boost its growth profile in the process.
While there are plentiful opportunities to grow the top line, there are -- as at Altria -- sizeable, wide-ranging cost-cutting efforts at PMI as well, with $1 billion in savings to be extracted between now and 2010. And the company's balance sheet will also begin to be utilized, with a $13 billion stock buyback and nice dividend.
But perhaps most important is PMI's first-class management team, led by the extremely capable and highly experienced Louis Camilleri, who moved over from Altria after the spinoff, and Andre Calantzopoulos, who ran PMI since 2002.
In contrast to Altria's leaders driving with one foot on the brake, I believe that the PMI management team feels like a turbo-charged sports car let loose on the open road after being constrained to school-zone speeds for far too long.
I expect to see a renewed focus on improving operating performance, developing innovative products and sharpening its execution. Costs will continue to get squeezed. Management, I believe, will be more aggressive in releveraging its balance sheet and will end up far exceeding its previously stated buyback commitment. PMI also has plenty of acquisition opportunities; I trust that Team Camilleri will wisely and efficiently deploy the company's capital as it vigorously pursues those opportunities.
All of that is to say that I like Altria, but I prefer the growth profile and management team of Philip Morris International.
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At time of publication, Norton was long Philip Morris, Altria and Carolina Group, though positions may change at any time.
Charles L. Norton, CFA is a principal of GNI Capital, an equity long/short money management firm that provides investment management services to institutional clients including mutual fund sponsors, trust companies, investment advisory firms, corporate retirement plans and family offices. Mr. Norton is responsible for portfolio management and investment research for all of the company's managed assets, including the Vice Fund (VICEX) and the Generation Wave Growth Fund (GWGFX). Previously, Mr. Norton had been a vice president in the equity research department of a New York-based hedge fund, where he also managed separate long/short equity accounts. Prior to his experience on the buy side, he was an investment banking analyst at Smith Barney. He has a bachelor of science in management degree in finance from Tulane University's A.B. Freeman School of Business, and is a CFA charterholder. He is a member of the CFA Institute and the CFA Society of Dallas-Fort Worth. While Mr. Norton cannot provide investment advice or recommendations, he appreciates your feedback; click here to send him an email.
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