Altria paid $12.8 billion for a 35% stake in Juul in 2018. The Marlboro maker made this investment, which has since been written down to $1.6 billion, to gain exposure to allegedly less harmful vaping products that seemed poised to win over a growing number of cigarette smokers.
However, Juul has faced increased regulatory scrutiny in recent years as the vaping giant's flashy marketing, fruity flavors, and sleek USB-like device fueled a spike in youth e-cigarette use.
To address this concern, the FDA banned fruit-flavored vaping products and required all domestic e-cigarette makers in 2020 to submit their products for review in order to remain on the market.
Regulators primarily wanted to ensure the marketing of these products was appropriate for public health and that their chemicals were less harmful than combusted cigarette smoke.
Two of Juul's largest competitors – Reynolds America and NJOY – gained clearance to keep their tobacco-flavored e-cigarettes on the market, making Juul's rejection surprising given the perceived similarities between their products.
Juul could pursue an appeal, challenge the decision in court, or file a revised application for its products, per the Wall Street Journal. This might allow Juul to keep its products on the market for now.
Regardless, this setback raises concerns that Juul could fall behind in the battle for vaping market share or even cease to exist in a worst-case scenario. After all, the U.S. accounts for virtually all of Juul's revenue, and the company lost over $250 million last year following an 11% fall in sales.
While Juul does not contribute materially to Altria's cash flow, the company represented an important bet on the future of nicotine as more traditional smokers seek out less harmful alternatives, a trend that could accelerate as regulators scrutinize nicotine levels in cigarettes.
Among these so-called reduced-risk products (RRPs), vaping has emerged as the largest category in the U.S., capturing 7% of the industry's nicotine value.
Tobacco heating products (THP), the main RRP rival to vaping made popular overseas by Philip Morris International's IQOS device, have minimal share in the U.S. so far, underscoring the importance of having exposure to e-cigarettes.
For now, business trends remain stable and supportive of the dividend. Industry cigarette volume declines have stayed at a manageable level that can largely be offset by higher pricing, keeping revenue steady. Coupled with high margins and share repurchases, Altria expects to record another year of mid-single-digit adjusted EPS growth in 2022.
This will keep the company's payout ratio near 75%, below management's 80% target. Altria's low leverage ratio also sits at its healthiest level since 2017, providing some flexibility to fund growth investments in smoke-free products.
The main concern is whether Altria will eventually be forced to step up its investments in RRPs, especially if cigarette consumption begins declining at a faster pace. A high payout ratio limits the amount of cash flow Altria retains for reinvestment, so this scenario could pressure the dividend.
Overall, we are comfortable maintaining Altria's Borderline Safe Dividend Safety Score following this latest setback for Juul. Altria's core cigarettes business remains a cash cow, and the government's efforts to reduce nicotine levels in cigarettes to non-addictive levels seem likely to face years of legal battles.
That said, Altria could prove to be a value trap if smoking rates begin declining faster than expected, an issue we will continue monitoring closely. The company's longer-term growth profile is also uncertain as the U.S. nicotine market evolves and responds to various regulatory pressures.
Conservative income investors desiring a less risky option in this space could consider Philip Morris International. This business owns the international rights to Altria's famous brands, including Marlboro. With operations in over 180 countries, Philip Morris's regulatory risk is diversified, and reduced-risk products already account for close to 30% of its revenue (up from next to nothing in 2015).