Moody’s: Menthol Ban Will Accelerate Decline in U.S. Tobacco Sales
Moody’s says the U.S. Food and Drug Administration’s plan to ban menthol cigarettes and menthol cigars is credit negative for the tobacco industry and settlement asset-backed securities, because once implemented, these measures will accelerate cigarette v
Moody's Investors Service stated that the U.S. Food and Drug Administration's (FDA) plan to ban menthol cigarettes and menthol cigars is negative for the tobacco industry and the credit of asset-backed securities, as these measures will accelerate the decline in cigarette sales and harm profitability once implemented.
Tobacco companies selling menthol cigarettes in the U.S. market will be negatively impacted, although some existing smokers may switch to non-menthol cigarettes, limiting the negative impact of such measures on consumption.
Given their strong financial metrics, tobacco companies are likely able to absorb any decline in performance without significantly lowering their credit metrics. Approximately 29% of cigarette sales in the U.S. are menthol-flavored, according to Euromonitor.
The FDA stated on April 29 that it would work to develop a regulation to ban menthol cigarettes and flavored cigars within the year. Moody's expects tobacco companies to seek to overturn this ban through the courts, so implementation may take time. Any ban must be scientifically justified; otherwise, it will not withstand judicial review.
The investor service agency estimates that excluding the menthol ban, U.S. cigarette sales will decline by 3%-5% over the next three to five years. However, it believes that banning menthol could accelerate this decline to a low double-digit percentage. Moody's wrote in a report to investors: "We expect tobacco companies to be able to take pricing actions to initially offset this decline, but over time, as cigarette prices decrease, their ability to do so will weaken."
"We believe that banning menthol cigarettes (which account for 29% of U.S. cigarette sales) could also increase illegal trade, leading to revenue losses for legitimate manufacturers, as well as federal, state, and local government tax revenue losses."
Moody's noted that among the most exposed companies are British American Tobacco and Altria Group. British American Tobacco, through its subsidiary Reynolds American Inc., derives about 20-25% of its operating profit from menthol cigarettes. Altria Group derives about 20% of its sales from menthol cigarettes.
Given their strong financial metrics, tobacco companies are likely able to absorb any decline in performance without significantly lowering their credit metrics.
Moody's Investors Service
British American Tobacco accounts for about 45% of its operating profit, with menthol cigarettes accounting for about 50% of that. Moody's estimates that Imperial Brands generates about 10% of its operating profit from menthol cigarette sales, with menthol cigarettes accounting for about 45% of its total profit contribution in the U.S. Like Altria Group, British American Tobacco also has alternative products in the U.S. market, such as oral tobacco and vaping products, which can at least partially provide alternatives for menthol smokers.
Given its high market share, Altria will be affected by the menthol ban; however, several factors may mitigate this impact. Altria Group offers a range of non-combustible alternatives, such as e-cigarettes (through its 35% investment in Juul) and oral tobacco, which smokers may switch to if the menthol ban is implemented. Altria Group also sells IQOS heated tobacco devices in the U.S. under a licensing agreement with Philip Morris International. The FDA has authorized IQOS as a modified risk tobacco product, and if menthol products are banned, IQOS may gain new users.
Finally, Altria Group has strong financial metrics and may change its financial policies to offset declines in operating performance, including reducing its dividends or stock buyback activities.
Moody's stated that PMI has no direct exposure to the U.S. cigarette market and will not be negatively affected by this ban.
The FDA intends to begin the process of advancing two tobacco product standards aimed at banning menthol in cigarettes and all flavors in cigars. The agency specifically seeks to reduce the number of new smokers and increase the likelihood of existing menthol smokers quitting, addressing health disparities among minority populations, as the FDA stated that the use of flavored cigarettes is high.
We believe that banning menthol cigarettes (which account for 29% of U.S. cigarette sales) could also increase illegal trade, leading to revenue losses for legitimate manufacturers and federal, state, and local government tax revenue losses.
Moody's Investors Service
Tobacco companies argue that the scientific evidence published to date does not support different regulations for menthol and non-menthol cigarettes, and that scientific evidence does not show that menthol cigarettes have different health risks compared to non-menthol cigarettes. Both companies state that scientific evidence does not support that menthol cigarettes have adverse effects on initiation, dependence, or withdrawal.
Other markets have implemented similar bans, including Canada in 2017 and the EU in 2020. While the impact of such bans on overall cigarette consumption is still being assessed, the overall decline in cigarette sales by tobacco companies has not significantly changed so far.
The ban on menthol cigarettes in the U.S. will also have a negative credit impact on long-term tobacco settlement bonds backed by payments from the 1998 Master Settlement Agreement (MSA). The performance of these ABS is directly tied to annual cigarette volumes in the U.S., and the accelerated decline in cigarette sales will severely reduce bond yields. The MSA includes certain alternative tobacco products, such as heated tobacco devices used with IQOS, which are part of the revenue-sharing income. However, according to Moody's, these alternative products are still in their infancy in the U.S., and if the FDA implements its menthol cigarette ban, their sales will not offset the substantial revenue decline.
Tobacco companies selling menthol cigarettes in the U.S. market will be negatively impacted, although some existing smokers may switch to non-menthol cigarettes, limiting the negative impact of such measures on consumption.
Given their strong financial metrics, tobacco companies are likely able to absorb any decline in performance without significantly lowering their credit metrics. Approximately 29% of cigarette sales in the U.S. are menthol-flavored, according to Euromonitor.
The FDA stated on April 29 that it would work to develop a regulation to ban menthol cigarettes and flavored cigars within the year. Moody's expects tobacco companies to seek to overturn this ban through the courts, so implementation may take time. Any ban must be scientifically justified; otherwise, it will not withstand judicial review.
The investor service agency estimates that excluding the menthol ban, U.S. cigarette sales will decline by 3%-5% over the next three to five years. However, it believes that banning menthol could accelerate this decline to a low double-digit percentage. Moody's wrote in a report to investors: "We expect tobacco companies to be able to take pricing actions to initially offset this decline, but over time, as cigarette prices decrease, their ability to do so will weaken."
"We believe that banning menthol cigarettes (which account for 29% of U.S. cigarette sales) could also increase illegal trade, leading to revenue losses for legitimate manufacturers, as well as federal, state, and local government tax revenue losses."
Moody's noted that among the most exposed companies are British American Tobacco and Altria Group. British American Tobacco, through its subsidiary Reynolds American Inc., derives about 20-25% of its operating profit from menthol cigarettes. Altria Group derives about 20% of its sales from menthol cigarettes.
Given their strong financial metrics, tobacco companies are likely able to absorb any decline in performance without significantly lowering their credit metrics.
Moody's Investors Service
British American Tobacco accounts for about 45% of its operating profit, with menthol cigarettes accounting for about 50% of that. Moody's estimates that Imperial Brands generates about 10% of its operating profit from menthol cigarette sales, with menthol cigarettes accounting for about 45% of its total profit contribution in the U.S. Like Altria Group, British American Tobacco also has alternative products in the U.S. market, such as oral tobacco and vaping products, which can at least partially provide alternatives for menthol smokers.
Given its high market share, Altria will be affected by the menthol ban; however, several factors may mitigate this impact. Altria Group offers a range of non-combustible alternatives, such as e-cigarettes (through its 35% investment in Juul) and oral tobacco, which smokers may switch to if the menthol ban is implemented. Altria Group also sells IQOS heated tobacco devices in the U.S. under a licensing agreement with Philip Morris International. The FDA has authorized IQOS as a modified risk tobacco product, and if menthol products are banned, IQOS may gain new users.
Finally, Altria Group has strong financial metrics and may change its financial policies to offset declines in operating performance, including reducing its dividends or stock buyback activities.
Moody's stated that PMI has no direct exposure to the U.S. cigarette market and will not be negatively affected by this ban.
The FDA intends to begin the process of advancing two tobacco product standards aimed at banning menthol in cigarettes and all flavors in cigars. The agency specifically seeks to reduce the number of new smokers and increase the likelihood of existing menthol smokers quitting, addressing health disparities among minority populations, as the FDA stated that the use of flavored cigarettes is high.
We believe that banning menthol cigarettes (which account for 29% of U.S. cigarette sales) could also increase illegal trade, leading to revenue losses for legitimate manufacturers and federal, state, and local government tax revenue losses.
Moody's Investors Service
Tobacco companies argue that the scientific evidence published to date does not support different regulations for menthol and non-menthol cigarettes, and that scientific evidence does not show that menthol cigarettes have different health risks compared to non-menthol cigarettes. Both companies state that scientific evidence does not support that menthol cigarettes have adverse effects on initiation, dependence, or withdrawal.
Other markets have implemented similar bans, including Canada in 2017 and the EU in 2020. While the impact of such bans on overall cigarette consumption is still being assessed, the overall decline in cigarette sales by tobacco companies has not significantly changed so far.
The ban on menthol cigarettes in the U.S. will also have a negative credit impact on long-term tobacco settlement bonds backed by payments from the 1998 Master Settlement Agreement (MSA). The performance of these ABS is directly tied to annual cigarette volumes in the U.S., and the accelerated decline in cigarette sales will severely reduce bond yields. The MSA includes certain alternative tobacco products, such as heated tobacco devices used with IQOS, which are part of the revenue-sharing income. However, according to Moody's, these alternative products are still in their infancy in the U.S., and if the FDA implements its menthol cigarette ban, their sales will not offset the substantial revenue decline.
