Altria makes big bets on vaping, cannabis

After a multibillion-dollar spending spree at the end of 2018, Howard Willard, the chairman and CEO of Henrico County-based Altria Group Inc., spent most of a January conference call telling analysts that investor worries about the tobacco giant’s headline-grabbing deals are unfounded. In fact, he said, prospects for the next five years are bright.

“In summary, 2018 was a transformative year for Altria,” Willard told analysts.

But if the concerns of Altria shareholders were satisfied, those of Dr. Scott Gottlieb, the commissioner of the Food and Drug Administration, apparently were not.

Altria is best known as the parent company of Philip Morris USA, the maker of Marlboro, the best-selling cigarette brand in a profitable but declining industry.

In early December, Altria  announced the $1.8 billion purchase of a 45 percent stake in Toronto-based Cronos Group Inc., which produces and sells medicinal marijuana products.

Two weeks later, the company spent an eye-popping $12.8 billion for a 35 percent stake in Juul Labs, a Silicon Valley startup that dominates the $6.5 billion North American vaping products market.

“We believe that Juul and Cronos present unique opportunities to meaningfully participate in fast-growing adjacent categories,” apart from tobacco, Willard said during the conference call.

In early February, however, Gottlieb called for a meeting with Altria and Juul officials to discuss “inconsistent” statements about efforts to combat a surge in underage use of e-cigarettes, according to The Associated Press.

In a letter to Willard, the FDA commissioner said he wants the companies to explain how plans to expand Juul sales to 230,000 retail locations are consistent with Altria’s pledge to address “the mounting epidemic of youth addiction to tobacco products.”

Altria responded, telling the AP that it and Juul “have taken significant steps that exceed what others in the industry have done.”

Altria has taken its own e-cigarettes off the market while Juul dropped many of its flavored vaping products and ended its social media promotions. Altria supports raising the legal age for buying tobacco products from 18 to 21.

In February, Gov. Ralph Northam signed a bill passed by the General Assembly raising Virginia's legal age to 21. The commonwealth joins six other states that have made the change. 

“[Under-age tobacco use] is an issue that we and others in the industry must continue to address aggressively and promptly,” Willard said in the January conference call. “We understand that the long-term opportunity of tobacco harm reduction is threatened by continued under-age use.”

Gottlieb told the AP that his agency could take steps to further restrict e-cigarettes if underage vaping continues to soar. Nonetheless, he is reluctant to overregulate an industry that could provide safer alternatives for adult smokers.

A British study published in January by the New England Journal of Medicine found that switching to e-cigarettes was more effective than nicotine patches, gums and lozenges in helping smokers quit.

A majority stake?
Altria’s stock declined 30 percent last year, largely because of the overall selloff on Wall Street but also because many investors were surprised by the $14.6 billion in e-vapor and cannabis investments.

Some Altria shareholders were concerned about any impact the deals might have on its long record of paying attractive dividends. In the conference call, however, Willard said the investments will help the company deliver long-term shareholder value through earnings growth and dividends.

“Altria enters 2019 with an evolved business platform that includes our strong, core tobacco businesses with new strategic investments with tremendous potential for growth,” he said.

To help pay for the deals, Altria is eliminating 900 salaried positions nationwide as it reduces costs by $575 million. The job reduction represents just over 10 percent of its workforce of 8,300 employees.

Altria retains the option to buy an additional 10 percent share of Cronos within the next four years for another $1 billion. That raises the possibility that a Virginia-based tobacco company whose roots go back to the early 19th century soon could own a majority stake in a cutting-edge cannabis products company.

Last May, Martin J. Barrington, Altria’s former chairman and CEO, indicated that cannabis and its derivatives were not something the company wanted to sell.

In his final appearance before shareholders at the company’s annual meeting in Richmond, Barrington said,  “As long as it is illegal, it is not a category we are interested in.”

Recreational use of marijuana became legal in Canada in October.  However, the personal, recreational use of marijuana — because of the presence of tetrahydrocannabinol (THC), a powerful psychoactive substance of the cannabis plant — remains illegal in the U.S. under Schedule 1 of the 1970 Controlled Substances Act.

Yet, full enforcement of that provision of the law by the Drug Enforcement Agency, the U.S. Department of Justice and local police departments has been inconsistent since the law was passed.

Meanwhile, the FDA has ap­­proved for widespread sale a single cannabis-oil product derived from the marijuana plant, Epidiolex. It contains much more of cannabidiol, or CBD, the non-psychoactive substance of the marijuana plant, and relative trace amounts of THC.

Still, while CBD oil made from non-marijuana hemp plants are widely available for a variety of remedies for pain, insomnia and other problems, the FDA has warned that it may crack down on companies that make unproven health claims.

At last count almost three dozen U.S. states, the District of Columbia, Guam and Puerto Rico permit medical sales of cannabis derivatives with a doctor’s recommendation. Virginia recently approved the limited sale of CBD oil with a low level of THC, but only with a doctor’s recommendation.

Full recreational use of marijuana and related products, containing various levels of THC, is permitted in 10 U.S. states, the District of Columbia and the Northern Mariana Islands. Simple possession of small amounts for personal use has been decriminalized in 13 other states and the U.S. Virgin Islands.

The online Marijuana Business Daily has estimated that annual U.S. marijuana sales — both medical and recreational — will almost quadruple to more than $20 billion by 2022 from roughly $6 billion in 2017.

Looking even further ahead, Altria told analysts in January that by 2028 the annual worldwide market for marijuana and its many derivative products could total from $40 billion to $250 billion, depending on the number of countries where it eventually becomes fully legal to use, like alcohol or tobacco is today.

Another reboot
Even as worldwide sales for cigarettes remain sky-high compared with many other consumer products, Altria and Willard predict global demand for cigarettes will continue its steady decline.

The company now forecasts that global cigarette consumption will fall an average of 4 to 5 percent annually through 2023, after dropping by 4 percent in 2017 and 4.5 percent last year.

As a result, Altria is taking yet another stab at diversifying its product portfolio to lessen its dependence on tobacco.

In the late 1980s, the company’s corporate predecessor, Philip Morris Inc., bought Kraft Foods to broaden its product offerings. After failing to meet the parent company’s profit expectations, Kraft was spun off in 2007.

That same year, Altria bought pipe tobacco and cigar producer John Middleton.  In 2009, the company bought United States Tobacco Co. — the maker of popular smokeless tobacco brands Skoal and Copenhagen — and the owner of Pacific Northwest-based wine maker Chateau Ste. Michelle Estates.

Along with Philip Morris USA, the company’s combustible tobacco cigarette division and by far its most important business unit, all three companies remain part of Altria.

Last year, the company said shipments of products in all three categories — smokable, smokeless and wine — dropped from 2017. Net revenue from operations rose only in the smokeless category, by 5 percent. It dropped by 1.5 percent for its smokable products and by 1 percent for wine.

In his conference call, Willard focused on the company’s investment in Juul, touting not only its growth but also the prospects of the global e-vapor marketplace.

Citing company data, Willard expects the steady decline in demand for traditional cigarettes to be offset by a steady 15 to 20 percent annual increase in global consumption of e-vapor products through at least 2023.

Altria says the U.S. domestic e-vapor industry grew by 35 percent last year, and worldwide sales totaled $23 billion last year. About $17 billion is spent on vaping products outside the United States.

Several weeks before announcing its minority stake in Juul, Altria scrapped its own early experiments in e-vapor products — MarkTen and Green Smoke — along with its line of Verve nicotine lozenges and chewables.

“We remain committed to being the leader in providing adult smokers innovative alternative products that reduce risk, including e-vapor,” Willard said at the time. “We do not see a path to leadership with these particular products and believe that now is the time to refocus our resources.”

Altria introduced MarkTen in 2013 in U.S. test markets and purchased Green Smoke in 2014 for $110 million. Verve’s low-nicotine chewables were first tested in 2012 and were considered an important component of the company’s small portfolio of smokeless, modified-risk products as recently as last spring.

Paired with Juul’s e-vapor technology, product innovation and marketing buzz, Altria’s expertise in retailing and distribution will enable the startup to sustain its dramatic growth, especially in international markets, Willard said in January.

The Altria CEO said that Juul, a pri­vately owned company, had net revenues of more than $1 billion last year, up from about $200 million in 2017. Altria officials predict that by 2023, with its expertise in merchandising and global operations, Juul’s income from international sales will match that of its domestic operations.

Cronos and cannabis
Willard said the company’s pending 45 percent stake in Cronos “will create a new growth opportunity in an adjacent category poised for rapid growth. It complements our strong core tobacco businesses and expands our income opportunity beyond the U.S.”

Similar to its plans for Juul, Willard says Altria will be able to contribute its many years of accumulated expertise in manufacturing, sales, merchandising and marketing of tobacco products to help Cronos become a market leader in the development of cannabis products.

“We believe the growth opportunities [in the cannabis marketplace] are significant and will extend across the globe as cannabis markets open. Selecting the right partner in this category was critical, and we’ve done just that. Cronos’ strong management team has built unique capabilities to compete globally across the medicinal, recreational and nutraceutical categories,” Willard said.

(Nutraceutical products are defined as food products that may deliver health and medical benefits in addition to their basic nutritional value. They are not regulated by the FDA as rigorously as prescription medications.)

The U.S. companies that have preceded Altria into the market already have indicated how they may want to use cannabis derivatives to enhance their existing product lines.

Constellation Brands, the owner of the Modelo and Corona beers in addition to wine and distilled spirits brands, paid $4 billion last year for a minority stake in Canada’s largest cannabis company, Canopy Growth Corp.

The first goal, according to Constellation, is to sell more medicinal marijuana products in the 30 nations that currently permit it and then expand “to supply new recreational adult-use markets as cannabis becomes legal in markets around the world.”

Last August, the Canadian subsidiary of U.S. brewing giant Molson Coors entered into an agreement with Canada’s HEXO Corp. to create a line of nonalcoholic, cannabis infused beer.

Altria is a minority shareholder in Belgium-based Anheuser-Busch Inbev, one of the largest beer makers in the world. In December the beer company announced that its Labatt’s subsidiary will partner with Tilray, a leading Canadian cannabis products company, to develop nonalcoholic beers infused with THC and CBD.

Financial writer Keith Speights, in a February story published by The Motley Fool website, said that new cannabis products could impact a number of industries and consumer categories.

“There are multiple huge industries that cannabis could disrupt, from beverages to consumer wellness products to veterinary products. With Altria at its side, Cronos should have the resources needed to compete in any or all of these markets over time,” he wrote.