Quicker FDA Reviews Can Help Slow The Decline In Cigarette Volumes

Includes: MO
by: Trefis

Tobacco companies have introduced almost no new cigarettes in the U.S. for more than two years now because of the restrictions imposed by the federal government. This issue adds to the existing woes of the tobacco industry, which has been fighting consistently declining shipment volumes with a very small degree of freedom. However, there appears to be some respite coming to the industry as the Food and Drug Administration says it is "very close" to deciding on some of the 4,000 new product applications it has. This should be seen as a positive sign for companies such as Altria Group (NYSE:MO), which has witnessed an acceleration in consistently declining cigarette volumes of late.

What Led to the Slump in New Products?

The Family Smoking Prevention and Tobacco Control Act that became a law on June 22, 2009, gave the FDA the authority to regulate the manufacturing, distribution and marketing of tobacco products in order to protect public health. Among many other regulatory tasks assigned to the agency under this law was the "Premarket Review" of tobacco products. This requires any new product to be approved by the FDA before launching in the market.

Since then, around 4,000 new product applications have piled up at the FDA. However, a majority of these can already be seen in the market -- one of the clauses of the law allowed products substantially similar to those already being sold as of February 2007 to be marketed while still being reviewed by the regulatory agency. But 500 of these 4,000 "new" products have not seen the light of day yet as they are still being reviewed by the FDA for any potential escalation of health-related issues that could be caused by their approval. Therefore, the review of these 500 products is being prioritized by the agency and we can expect to see some action on this front in the coming months.

It should be noted that unlike drugs that are used for medication purposes, the potential for any significant variation in tobacco products is fairly limited. Therefore, such extensive delays in the review process by the FDA that has led to the current pileup of applications only indicates extra caution on the part of the regulatory agency.

How Can a Faster Review Help the Industry?

Issues such as frequent excise-tax hikes, marketing restrictions, and increasing health awareness are some of the most prominent operating risks inherent in the tobacco sector in the U.S. (see "Where Is The U.S. Cigarette Industry Headed?"). Against the backdrop of these aggravating issues, new products form a vital source of demand stimulation for the tobacco industry. Therefore, preventing companies from marketing new products can be detrimental to their business. Not only that, the threat of discontinuation of any of the existing products simultaneously being reviewed by the FDA further adds to the uncertainty.

Although an FDA review can go either way, even a denial to any application will bear the fruit of reduced uncertainty around the kind of products expected to be allowed by the agency. As far as a clean chit to a new product is concerned, we believe that it will act as a positive force in driving volumes and will indirectly help the manufacturer in arresting consumption decline to some extent. This is because it will give the manufacturer an opportunity to increase stock keeping units (SKUs) and crowd shelf space, providing consumers with an expanded choice at the same time. Hence, we feel that a quicker review of tobacco products by the FDA will be a positive for the industry overall. We will be keeping a close watch on any developments on this front.

We currently have a $37 price estimate for Altria, which is in line with the current market price.

Disclosure: No positions.