Shares of Altria Group (MO) dropped in morning trading after an analyst downgraded the stock to Market Perform, telling investors that she sees accelerating declines in an already deteriorating U.S. cigarette market. 

ACCELERATING DECLINES, DETERIORATING MARKET: Cowen analyst Vivien Azer downgraded Altria to Market Perform from Outperform and lowered her price target to $53 from $74. In a research note to investors, Azer said that Altria's cigarette volumes will drop at a 7.3% compound annual growth rate, or CAGR, over the next five years, compared to the average decline of 3.1% over the last five years.

"Although the Juul investment was likely the right move, Altria is incentivized to accelerate cigarette industry volume declines" in the already deteriorating U.S. cigarette market, Azer said in a note titled "Tumultuous times in tobacco for Altria." Azer lowered her net sales growth for 2019 to 2023 by 60 bps to 1.9% to reflect accelerating volume declines. "Juul is probably a good deal for Altria that suffers from poor timing, and would be a key factor in our getting more constructive on the name," the analyst added. She expects pricing to continue to be an offset, and would expect pricing to accelerate in tandem with volume declines, but not to the magnitude to sustain the category's historic 2%-3% top-line growth.

She further contended that while Altria's management is targeting accretion from the combination of Juul, Cronos (CRON) and cost savings initiatives within two years, "it is apparent that the base business will have its own challenges." 

OTHER SECTOR DOWNGRADES: Separately, Cowen's Azer downgraded British American Tobacco (BTI) and Imperial Brands (IMBBY) to Market Perform from Outperform. The analyst said she is growing increasingly cautious on the outlook for combustible cigarettes in the U.S. as her model suggests cigarette industry volumes will likely fall at an 8% CAGR between 2018-2025 with price not serving as an adequate offset. 

WHAT'S NOTABLE:  On December 20, Altria announced a $12.8B investment in Juul Labs, which it called "the U.S. leader in e-vapor." Altria's investment, which had been widely expected following recent media reports, represents a 35% economic interest in JUUL, valuing the company at $38B. Juul has drawn criticism over its products' popularity with teens and the U.S. Food and Drug Administration previously announced plans to place restrictions on sales of flavored e-cigarettes. Juul also said it would restrict sales of nearly all its flavored pods to the internet, and stop most social media promotion to combat youth vaping. Altria previously said it would pull its pod-based e-vapor products from the market until approved by FDA.

Altria's investment in Juul came on the heels of its announcement that it will take a 45% stake in cannabis company Cronos Groupand plans to discontinue its MarkTen and Green Smoke e-cigarette products and its Verve oral nicotine. Following the deal news, several Wall Street analysts voice the opinion that the price the company is paying for its 35% stake in Juul is a high cost that has the potential, as one put it, to "destroy value." 

Citi analyst Adam Spielman downgraded Altria to Sell, telling investors that he believes the Juul stake news is likely "destroying value,"but that it is impossible to be sure as Altria has not revealed any financial details "despite the scale of the investment." He added that the deal weakens Altria's existing business, as it allows Juul to directly contact Altria's current consumers, to try to persuade them to switch from Marlboro to Juul. Meanwhile, Morgan Stanley analyst Pamela Kaufman said Altria's move comes at a high price, noting that the $38B valuation represents more than double the $16B valuation that JUUL received in an investment round last summer. Additionally, the analyst sees risk in Altria's lack of operating control and the potential for further FDA regulation.

According to a report on Friday from The New York Times, FDA commissioner Scott Gottlieb is drafting letters to both Altria and Juul that will that will criticize them for publicly pledging to remove nicotine flavor pods from store shelves, while secretly negotiating a financial partnership that seems to do the opposite. "Juul and Altria made very specific assertions in their letters and statements to the FDA about the drivers of the youth epidemic," Gottlieb said, adding that "Their recent actions and statements appear to be inconsistent with those commitments." 

PRICE ACTION: In morning trading, shares of Altria are down 3% to $48.77. [Closing price $48.78]