The e-cigarette business continues to face mounting headwinds following recent reports of a lung disease outbreak across the U.S.

The crackdown by some states and other municipalities on the use of vaping products has spurred tobacco giants such as Altria Group (NYSE: MO) and Philip Morris International (NYSE: PM) to contend with increasing pressure to stave any potential revenue losses.

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New York State governor Andrew Cuomo inflicted a blow on the industry Tuesday when he banned the sale of flavored electronic cigarettes and nicotine e-liquids – effectively marking the first state in the country to enact the measure. [Michigan announced its plan Sept. 4 but did not enact it until today.]

Cuomo’s action followed a vote on emergency regulations by the Public Health and Health Planning Council and comes amid a nationwide focus on the targeting of e-cigarette sales to the youth population.

The New York governor said it is “undeniable that vaping companies are deliberately using flavors like bubblegum, Captain Crunch and cotton candy to get young people hooked on e-cigarettes – it’s a public health crisis and it ends today.” He added that “New York is not waiting for the federal government to act, and by banning flavored e-cigarettes we are safeguarding the public health and helping prevent countless young people from forming costly, unhealthy and potentially deadly life-long habits.”

Related Illnesses

The ban falls in the wake of a growing epidemic in the country that has resulted in fatalities, which the Centers for Disease Control and Prevention (CDC), the U.S. Food and Drug Administration (FDA), state and local health departments, and other clinical and public health partners have been investigating.

As of September 11, 2019, 380 cases of lung illness associated with the use of e-cigarette products have been reported to the CDC from several states, including Arizona, California, North Carolina, New York, Kansas, Texas, Ohio, and Virginia, among many others.

Of these cases, six deaths to date have been confirmed in California, Illinois, Indiana, Kansas, Minnesota, and Oregon.

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The growing concerns have reached the White House, where U.S. President Donald Trump said there have been “deaths and there have been a lot of other problems. ... People think it’s an easy solution to cigarettes, but it’s turned out that it has its own difficulties.”

Indeed, it appears that e-cigarette usage among adolescents in the U.S. has been surging, with that cohort lured by vaping flavors such as mint and menthol.

U.S. Secretary of Health and Human Services Alex Azar highlighted that about eight million adults use e-cigarettes, but five million children also consume them. Against this backdrop, he said that the FDA intends to finalize a guidance document that would enforce the removal of all flavors, other than tobacco, from the market.

JUUL Defends the Smoking Alternative

This news, along with a barrage of other negative headlines, has spurred a flurry of responses from major e-cigarette producer JUUL labs.

While the San Francisco-headquartered manufacturer responded to the remarks from the White House with a strong agreement for “the need for aggressive category-wide action on flavored products” and that it will “fully comply with the final FDA policy when effective,” other blows have come closer to home.

On June 25, the San Francisco Board of Supervisors voted to ban the sale of e-cigarettes within city limits, at both retail and online, until they go through the FDA regulatory process. Under current FDA policy, these products can stay on the market through August 2022, when manufacturers must submit a product application. 

However, JUUL warned that this “effective prohibition will drive former adult smokers who successfully transitioned to vapor products back to combustible cigarettes, deny current adult smokers the opportunity to move off combustible use altogether, and create a thriving black market instead of addressing the actual causes of underage access and use.”

Altria’s Stock Gets Smoked

Overall, the recent adverse developments in the e-cigarette space appear to have impacted traditional tobacco companies such as Altria (MO), which had diversified its business in December 2018 with a 35% stake, or a US$12.8bn investment, in JUUL.

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Altria’s stock fell nearly 1% to US$40.89 intraday Wednesday – a new 52-week low – with its Relative Strength Indicator (RSI) submerged in oversold territory, according to the IBKR Trader Workstation (TWS). The company has erased almost 38% of its value since its latest one-year peak set in late October 2018, amid plans in late August 2019 to form an all-stock merger-of-equals with Philip Morris International.

Gimme Credit analyst Carol Levenson recently noted that “Altria remains a cash machine, despite social, legal, and regulatory challenges. Although it is more diversified than most cigarette companies, one should never forget that over 85% of its profits still come from selling cigarettes and cigars. This makes for fat margins but meaningful business risk.”

In terms of the merger, she said the litigation environment that prompted Altria to spin off PM in the first place (back in 2008) “has receded,” while the “secular decline in smoking has accelerated to the point that the companies feel the need to re-consolidate to combat it through developing alternative products and reaping acquisition synergies.”

She continued that although Altria’s leverage is elevated, largely due to its investments in JUUL and cannabis company Cronos, both it and PM typically carry leverage in the 1.5-2.5x range, adding that pro forma leverage for the combined entity would be about 2.3x, with “modest free cash flow generation” – assuming the dividend of the new entity in total is the same as the combined current dividends, and that synergies of 5% of combined sales can be achieved.

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Against this landscape, PM stock has also been on a downward swing recently. Intraday Wednesday, the firm was off almost 1% at US$71.35, with shares of the company down around 22.4% since its latest 52-week peak set in March 2019, according to TWS.

Meanwhile, the U.S. e-cigarette market is expected to reach US$16.5bn by 2024, but the success of that figure is generally contingent on factors that include “increasing awareness among consumers, easy availability of e-cigarettes, online distribution of products, technological advancements, and high prevalence of smoking related diseases,” according to VynZ Research.

Sales numbers from Statista show electronic cigarette consumption has been climbing year-over-year to reach US$3.6bn in 2018, up from US$2.9bn in the prior year.