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It has been a long time coming, but the announcement by the US Food and Drugs Administration, the US regulatory agency tasked with keeping tabs on the tobacco sector since 2009, has dramatic and far-reaching implications for big tobacco stocks.

The FDA said yesterday it was consulting on a move to limit the addictive qualities of cigarettes entirely, proposing to cut the level of nicotine in cigarettes to non-addictive levels. The tobacco industry has been battling a slew of multi-million dollar lawsuits in the US over the past decade, but this move will be a much harder threat to defend itself against.

So what does this mean for tobacco stocks?

Shares in tobacoo stocks were crushed on Friday afternoon. There was some buying towards the end of the UK and US trading sessions, but frankly, we can’t see how Big Tobacco is going to dig its way out of a situation where its core product can no longer be addictive. If cigarettes are no longer going to be addictive, sales in developed markets are going to shrink to a tiny fraction of what they were before.

“It is hard to overstate what this could mean for the companies affected,” said Neil Wilson, Senior Market Analyst with ETX Capital. “Non-addictive levels of nicotine would likely mean a lot fewer smokers and of those people who do still light up, smoking a lot less. This will blow a hole in their earnings and forces a fundamental re-evaluation of earnings.”

It is going to be a hard rest of the summer for tobacco stocks. You can almost hear tobacco CEOs speed-dialling their lobbyists in Washington DC, but much of the damage is already done, and the FDA is not Congress. British American Tobacco fell 13% on the news, before returning to a net loss of 8% on the day. Imperial Brands finished Friday 7% lower. It was a dramatic intra day short selling opportunity for the canny Contracts for Difference trader.

Altria was another casualty, falling 16%. Investors in its stock were waking up this morning to a world where cigarettes may no longer be able to create or sustain addiction.

Friday afternoon trading in tobacco stocks was pretty volatile, with prices bouncing around as analysts and traders struggled to get to grips with what this means for future valuations for tobacco stocks. The implications are severe, as many developed world regulators are likely to act in concert. Just look at how the ban on smoking in bars and restaurants has been spreading across the world.

“This is just the US regulator acting, but we can see others, particularly in Europe, where regulatory pressures are already extremely high, following suit,” Wilson said.

Volumes in the market were already starting to decline ahead of the summer break. Typically August will lead to more volatility for the brave. But still, we can’t see how Big Tobacco can come back from this. Tobacco executives may be hoping they can rely on their sales in developing markets to keep them alive, but even big markets like China saw a decline in overall tobacco sales, down 2% last year, and likely the same this year.

Michael van Dulken, Head of Research at Accendo Markets, said he thought the sector may have been oversold, arguing that the plan announced by the FDA is really just one to start a public dialogue focusing on the protection of children and reducing tobacco disease and related deaths.

What next for tobacco stocks?

The fine print in the FDA announcement suggests balancing the regulation of existing products and encouraging innovation to develop less harmful products in the future. There may be exemptions and delayed implementation that may offer some relief for Big Tobacco, but we have this to say in return: have you seen the Marlboro Man recently?

The news has likely not properly settled in with some investors.

In addition, analysts will not have had time to properly evaluate what the FDA is saying and what the implications are for tobacco stocks. We’re going to see some more volatile trading in tobacco stocks next week, and some short to medium term shorting opportunities.

We’d call this as Short of the Week, but it just seems too big for that.

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Please note this article does not constitute investment advice. Investors are encouraged to do their own research beforehand or consult a professional advisor.

Stuart Fieldhouse

Stuart Fieldhouse

Stuart Fieldhouse has spent 25 years in journalism and marketing, including as a wealth management editor for the Financial Times group, covering capital markets and international private banking, and as an investment banking correspondent for Euromoney in Hong Kong. He was the founder editor of The Hedge Fund Journal.

Stuart has worked at CMC Markets, supporting the re-launch of its global financial spread betting and CFD trading platforms. He is also the author of two books on trading, published by Financial Times Pearson. Based in The Armchair Trader’s London office, Stuart continues to advise fund managers, private banks, family offices and other financial institutions.

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