E-Cigarettes: Proposed Regulations Could Prove To Be A Game Changer

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Includes: LO, MO, PM, RAI
by: Horizon Investments

Summary

Short-term picture may remain unchanged but same cannot be said for the medium to long term.

Regulation stipulations will result in additional costs.

Smaller companies may exit market as FDA fills prevalent regulation vacuum.

Increasing consumer awareness, health issues and sturdy regulations have affected the $800 billion global cigarette market. Sales volume has been trending down for the market and tobacco companies are mainly relying on price increases to support growth; global sales volumes were down about 3% YoY in 2013. As the market situation for traditional tobacco products remains challenging, E-cigarettes (e-cigs) are expected to provide growth in upcoming years; however, the growth potential of e-cigs could be challenged by regulations.

Regardless of the fact that awareness and sales of e-cigs have grown at a robust pace, e-cigs remain a small part of the $95 billion U.S. tobacco market. Sales of e-cigs in the U.S. increased to $1.5 billion in 2013, as compared to $500 million in 2012. Despite the growing popularity of e-cigs in the past, the recently proposed regulations by the FDA could prove to be a game changer in the future for the e-cigs market. Recently, the FDA in an attempt to regulate e-cigs proposed regulations; the recommendations are open for public comments for 75 days, after which they will be finalized. Some of the proposed regulations include limiting e-cigs sales to minors, requiring additional health warnings, banning free samples, requiring registration of all products and ingredients by companies with the FDA and mandatory pre-market reviews. E-cigs manufacturers will have two years to submit an application for new products or to submit an application to get approval for their existing products to remain on the market.

The proposed regulations will also require manufacturers to conduct studies to get approval from the FDA, which will not only be a time-consuming process, but will also add on to the costs of launching new products. The pace of new product innovation would also get affected because of pre-market study requirements and the additional cost burdens attached to it.

In my opinion, the proposed regulation could change the e-cigs market landscape in the medium to long term, as small companies with limited financial muscle will be moved out of the market and forced towards consolidation. Big tobacco companies like Altria Group (NYSE:MO), Philip Morris (NYSE:PM), Lorillard (NYSE:LO) and Reynolds (NYSE:RAI) are likely to address the proposed regulations smartly and benefit in the long term, as they have deep pockets and the regulatory expertise to get approval for new products or keep putting products on the market. Also, the proposed regulations could limit competition, as small companies will be moved out of the market and big companies will dominate.

The approval process remains an important concern for e-cigs manufacturers, as e-cigs launched within two years after the finalization of rules and existing e-cigs will have to submit product applications to get approval from the FDA to keep products on the markets. Also, prior sales (pre-market) approval will be required from the FDA for e-cigs introduced after two years of the rules being finalized.

The proposed regulations could slow down e-cigs' growth pace. In the U.S., e-cigs sales tripled to $1.5 billion in 2013, as compared to 2012. And according to Bloomberg estimates, e-cigs sales might hit the $5 billion mark in 2015, down from the earlier projections of $6 billion in 2015.

Final Words

The proposed regulations might not have significant short-term impacts, but could prove to be a game changer in the medium to long term. The approval requirement will add to product costs, forcing consolidation in the industry as small companies exit the market due to a lack of financial resources to keep up with regulatory requirements, benefiting large tobacco companies. However, a positive take-away from the FDA's recommendation is that the proposed regulation will help fill a regulatory vacuum.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.