tocacco plant Native American Tobaccoo flower, leaves, and buds

tocacco Tobacco is an annual or bi-annual growing 1-3 meters tall with large sticky leaves that contain nicotine. Native to the Americas, tobacco has a long history of use as a shamanic inebriant and stimulant. It is extremely popular and well-known for its addictive potential.

tocacco nicotina Nicotiana tabacum

tocacco Nicotiana rustica leaves. Nicotiana rustica leaves have a nicotine content as high as 9%, whereas Nicotiana tabacum (common tobacco) leaves contain about 1 to 3%

tocacco cigar A cigar is a tightly rolled bundle of dried and fermented tobacco which is ignited so that its smoke may be drawn into the mouth. Cigar tobacco is grown in significant quantities in Brazil, Cameroon, Cuba, Dominican Republic, Honduras, Indonesia, Mexico, Nicaragua, Sumatra, Philippines, and the Eastern United States.

tocacco Tobacco is an agricultural product processed from the fresh leaves of plants in the genus Nicotiana. It can be consumed, used as an organic pesticide, and in the form of nicotine tartrate it is used in some medicines. In consumption it may be in the form of cigarettes smoking, snuffing, chewing, dipping tobacco, or snus.

tocacco Cigarettes are smoking products consumed by people and made out of cut tobacco leaves. Cigars are typically composed completely of whole-leaf tobacco. A cigarette has smaller size, composed of processed leaf, and white paper wrapping. The term cigarette refers to a tobacco cigarette too but it can apply to similar devices containing other herbs, such as cannabis.

FDA Regulation Will Broadly Affect Big Tobacco

On June 22, President Barack Obama signed into law a tobacco regulatory bill giving the U.S. Food & Drug Administration oversight of the industry, including the tobacco companies’ manufacturing and marketing practices. The changing regulatory environment has raised questions about the credit implications for the tobacco industry.

The legislation will give the FDA authority to restrict certain marketing and advertising practices, oversee the manufacturing of cigarettes, and demand detailed disclosure of tobacco products’ ingredients—while requiring the tobacco companies to pay for the additional oversight through user fees. It will also mandate larger, more prominent health warnings on labels and ban all flavored cigarettes except menthol products.

All of these policies may in our view alter the competitive environment in the industry by hindering new product development, putting up barriers to entry, and raising the overall cost of doing business.

Philip Morris USA, the largest U.S. tobacco manufacturer, has stated its support for the bill, while R.J. Reynolds and Lorillard, the second- and third-largest industry players, opposed it. Competitors have criticized Philip Morris, claiming that the sales, marketing, and advertising restrictions would help the company maintain its market share.

Despite the broad potential effects of the FDA regulations, we don’t expect the bill’s passage to have an immediate impact on our ratings and outlook on the largest-rated tobacco manufacturers or on tobacco settlement-backed securitizations (structured transactions secured by payments from participating manufacturers under the 1998 Master Settlement Agreement [MSA]). In addition, we don’t expect to make changes to our current criteria assumptions for tobacco settlement-backed securitizations as a result of the legislation. Our ratings on all such securitizations currently have negative outlooks or are on CreditWatch negative, and we believe our existing assumptions adequately address the risks inherent in these transactions.
Effects On Tobacco Industry Players

We don’t expect the FDA regulations to have an immediate rating impact on the tobacco manufacturers, including the three largest companies by market share: Richmond (Va.)-based Altria Group (MO) (S&P rating, BBB), parent of Philip Morris USA; Reynolds American (RAI) (BBB-), parent of R.J. Reynolds Tobacco; and Lorillard Inc. (LO) (BBB-), parent of Lorillard Tobacco.

We believe that these manufacturers’ strong cash flow generation, solid margins, and respective market positions provide support to their current ratings and partly offset the risks associated with FDA regulation, in addition to ongoing litigation risk and contraction in the domestic cigarette industry. However, our negative outlook on Lorillard reflects greater uncertainty about the impact FDA regulation may have on the menthol cigarette category, given the company’s greater exposure and leading position in this category. We would consider lowering the rating on the company if we believe that future changes in policy will materially affect Lorillard’s business, including further restrictions or a potential prohibition on the sale of menthol cigarettes.

We also believe the regulations may pose risks to the domestic tobacco industry as a whole over an intermediate to long-term time frame, and we will continue to monitor the situation as the new FDA tobacco-regulating entity takes shape—and as the government writes more detailed regulatory legislation.
Ad Curbs may favor MSA participants

The new legislation includes a number of marketing restrictions that would limit magazine advertising displays to black-and-white text, ban the descriptors “light,” “mild,” or “low tar” (which can imply that certain products are less harmful), and forbid free giveaways with the purchase of tobacco products. Some of the marketing restrictions—such as the prohibition on youth targeting, a ban on youth access to free samples, and limitations on tobacco brand name sponsorships—are part of the MSA guidelines that participating manufacturers (PMs) are already following.
The MSA, which the major tobacco manufacturers signed in 1998, settled various lawsuits that 46 U.S. states, the District of Columbia, and several U.S. territories had filed against the cigarette companies. The PMs currently include the original participating manufacturers, namely Philip Morris, R.J. Reynolds, and Lorillard—as well as more than 40 smaller tobacco companies that subsequently joined the MSA. The total market share of the PMs represents approximately 94% of the total domestic cigarette sales volume. The remaining estimated 6% is made up of the nonparticipating manufacturers (NPMs), which have not been subject to the MSA’s marketing restrictions. Thus we believe the marketing and advertising limitations may have a more significant impact on these companies.

Although we don’t expect the PMs will have to adjust their marketing practices significantly in the near future, we believe that further FDA restrictions could have more pronounced implications for these companies. Moreover the new legislation will allow individual states to impose their own restrictions on marketing and sales—in particular, on the way convenience stores and gas stations can display cigarettes—which would affect all manufacturers.
New-Product restraints hurt upstarts

We believe the legislation has the potential to change the competitive landscape in the industry. Specifically, the marketing and sales restrictions may make it more difficult for manufacturers to introduce new products or establish brand names. The FDA approval process can itself delay the launch of new products and the FDA will also be able to limit or ban the use of harmful ingredients in both existing and new tobacco products, which could alter their flavor and potentially reduce consumer acceptance of these products.

In addition, under the new legislation, the FDA will establish a Tobacco Scientific Advisory Panel that will evaluate issues surrounding the use of menthol as a flavoring agent or ingredient in cigarettes. Although we think an outright ban on menthol products is unlikely, we believe any future restrictions or prohibitions could hurt cigarette volumes in the menthol category, which accounts for approximately 30% of overall cigarette volumes.

Moreover we believe that companies seeking to strengthen market share through innovation—including smaller companies that may try to launch new brands or products—could have a harder time pursuing their competitive strategies under the new legislation. The bill also prohibits smokeless-tobacco manufacturers from implying in their marketing campaigns that smokeless products are safer or healthier than regular cigarettes.

We also think the increased regulatory scrutiny and the costs associated with brand development and launching new products might discourage some market participants from competing on innovation, forcing them to compete primarily on price. The restrictions would also, in our opinion, make it more difficult for tobacco companies to target smokers who might be interested in switching tobacco brands or trying new products. This in turn could help established tobacco products—many of which are produced by the PMs—to maintain market share.
Business costs will likely rise

We expect the FDA regulations to increase the costs of doing business for all manufacturers in the tobacco industry in two ways. First, the legislation imposes user fees directly on the tobacco companies to fund the new FDA regulatory entity. Various public sources estimate that the fees, which would be phased in over 10 years, could range between $0.01 and $0.02 per pack initially and increase up to $0.06 cents over the longer term. Second, the tobacco manufacturers will need to make changes in their marketing, advertising, and manufacturing practices to comply with the FDA rules, which, in our view, could prove more costly than the user fees.

We believe the increase in costs may be more burdensome to the smaller industry players, which don’t benefit from the economies of scale that could help the larger manufacturers cope with implementing the new processes. Moreover, the PMs already have some of these practices in place and may not need to make significant changes to their marketing and sales programs.
Little change to Litigation risks

We think the overall litigation risk in the tobacco industry will remain significant. There are generally two types of legal disputes that can have a negative impact on the cash flows for tobacco settlement-backed securitizations. The first type of suit challenges the validity of the MSA itself, and in some cases also challenges the model statutes that various states have enacted. The intention of the model-statute framework, as set forth in the MSA, was to prevent PMs from being put at a pricing disadvantage to the NPMs. A model statute accomplishes this parity by requiring the NPMs to make separate payments into an escrow account that would provide a source of funds to cover any potential future damage awards that the NPMs may be required to pay.

The second type of suit involves claims by PMs that they have lost market share to the NPMs since 1997, in which case payments by the PMs to the states and ultimately to the securitizations may be reduced.

These litigation risks, in our view, will remain at current levels.

© Copyright: Businessweek

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1 comment to FDA Regulation Will Broadly Affect Big Tobacco

  • Keats

    can anyone tell me if the native american cigarettes have any oversite of their manufacturing processes? I’m pretty much restricted to buying these brands now in New York State and they are absolutely HORRID. And please - I want to ask a question without some numbskull telling me to stop smoking.

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