The Real State of Big Tobacco

In retrospect, it’s not so hard to understand why Altria (NYSE: MO) supported FDA regulation of the tobacco industry. The Food and Drug Administration may have some control over product development and advertising for cigarettes and snuff, but when it comes to the big picture for the tobacco industry, the Feds are just a small piece of the pie.

Just ask your kids what they’re learning in social studies this week. You see, that old idea of “states’ rights” may be the real key to understanding Big Tobacco in America today.

Note to smokers: Retire in Florida!

Until recently, at least, litigious smokers had a reason to make the move to Florida. In 2006, the Florida Supreme Court ruled that jurors must acknowledge that tobacco companies knowingly hoodwinked consumers regarding potential health risks related to smoking. According to The Wall Street Journal, juries have delivered more than $250 million in damages to plaintiffs in the past two years, compared with $24 million in similar cases throughout the other 49 states combined.

But Altria and Reynolds American (NYSE: RAI) may find a sliver of hope as a federal court has ruled that plaintiffs may not automatically conclude that tobacco companies tricked consumers, a decision that could affect some 4,000 case in federal courts across Florida. Maybe Big Tobacco’s coffers won’t be open to plaintiffs forever in Florida, but these companies will surely spend countless resources (and dollars) to sort out the legal mess in the Sunshine State.

A tale of 50 states
The Washington Post recently featured an interesting op-ed piece outlining the effects that Maryland and Virginia state laws have had on smoking rates in both states. Basically, folks in Maryland quit smoking at a rate double the national average because of tough smoking laws and taxes. In comparison, Virginia’s decline in smoking has remained in line with the rest of America and ranks next to last among all states with a $0.30 tax per box of smokes. This isn’t surprising, considering Altria is the third largest company headquartered in Virginia.

Of course, the discrepancies in tobacco taxes reach much further than these two states. New York state tops the list with a whopping tax of $4.35 per box. In comparison, North Carolina, home to tobacco leaders Reynolds American and Lorillard (NYSE: LO), hovers close to the bottom of the list at a rate of $0.45 per box.

Bottom-line bucks
OK, so tobacco litigation and high taxes on smokes is nothing new. As the Fool has stated before, even with declining smoking rates, the tobacco industry is an interesting play. Altria leads the pack, tightly controlling costs to cover declining volume.

And even as states increase taxes, it is becoming clear that Big Tobacco can (and will) boost its prices to make up the difference. The Centers for Disease Control and Prevention reported that in 1970, taxes comprised 47.3% of the overall cost of a pack of cigarettes. Last year, even with the drastic increase in prices for cigarettes at a state and federal level, taxes were only 41% of the overall average pack cost. If you take inflation into account, then cigarette prices have increased by more than 150% from $0.38 in 1970 (or $2.10 in 2009 dollars) to a whopping $5.33 in 2009.

This is where the states’ rights argument comes into play for Altria and the others. If the federal government were to set aggressive per-box taxes across the board, then this could potentially affect the overall demand since the Feds could impose a New York-level tax that would rock a smoker’s world. As long as states have individual control over a large part of tobacco taxes and regulation, federal government intervention will only go so far.

Long-term strategies
Looking at the global tobacco picture, Philip Morris International (NYSE: PM) and British American Tobacco (NYSE: BTI) will fight similar battles across the globe as countries including Russia consider increasing taxes and monitoring advertising of tobacco products to decrease consumption rates.

Back in the USA, the federal government will always maintain partial control over the tobacco industry. And that’s actually the way Big Tobacco wants it. The Vector Group (NYSE: VGR) was among those begging the Feds to tax “roll your own” tobacco shops to avoid “unfair” tax advantages.

Altria and Philip Morris International are among those who will report earnings next week. I have to tell you that I won’t be surprised to hear that both companies are continuing to adapt to the dynamic market environment to serve stockholders primary goal: profit growth.

By Colleen Paulson

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