The Sin Industry: Altria’s Taking A Gamble On Vaping and Cannabis

  • Altria has historically been strong, but has dipped in value over the past year
  • They made a $12.8B stake in JUUL, pushing Juul to triple decacorn status
  • JUUL is a young company that has experienced substantial growth over the past three years, and currently represents the future of e-cigarette industry
  • Altria is breaking into the Cannabis industry through Cronos, a Canadian grower that is richly traded

The Background: How To Double Company Valuation in One Easy Step

Altria Group (MO) has invested $12.8B in Juul Labs, representing a 35% stake in the company.  They valued Juul at $38 billion, which is almost 2.4x the $16B valuation Juul received in July 2018, a little under 6 months ago. The total monetary amount of the investment represents $1.3 million per Juul employee, and is more than 25 times Juul’s revenue for 2018.

Juul has a valuation now that is more than that of SpaceX and Lyft, becoming the fastest startup in history to reach a valuation of more than $10B. This represents decacorn status, and Juul took only a little less than 6 months to achieve it. Facebook took 2.5 years to do the same thing. Snapchat took 2.8 years. Twitter took 4.4 years.

juul

Source: Yahoo Finance

Juul is now bigger, in terms of market capitalization than Target and Ford, which is quite an impressive metric for the three year old company. Altria richly paid for a company that has massive market share in the e-cigarette industry. But the deal is pretty sweet for Juul, giving them access to the powerhouse of resources that Altria has.

Diving into the Deal: Juul’s New Distribution Opportunities 

Altria is giving Juul access to logistics and distribution, as well as shelf space. Juul can market on the inside of cigarette packaging, and can access information about Altria customers. The CEO of Juul said that the partnership with Altria would “accelerate our success of switching adult smokers“. Juul initially founded itself as an enemy of Big Tobacco, but as they say, keep your friends close, but your enemies closer.

For Altria, they cannot increase their stake in Juul beyond 35% and cannot sell the stake for the next six years. Altria now represents approximately one-third of Juul’s board, but Juul will continue to operate as an independent company.

Regardless, Altria needed an outlet like Juul. Altria is down 34.2% from 52-week highs. The FDA is trying to ban menthol cigarettes which accounts for 20% of Altria’s profits. Also, there is a substantial decline in smokers, which is Altria’s target market. Between 2016 and 2017, there was a 3% decline in youth smokers, dropping from 13% to 10%. The cigarette industry is on a fast track downwards, with 16% of US adults smoking cigarettes in 2017.

adult cigs

Source: NKY Tribune

Cigarettes are notoriously expensive, and the negative social stigma associated with smoking continues to grow. Altria probably felt some sense of desperation. They needed to make headway into two of the fastest growing components of the smoking industry, cannabis and vaping. Juul Labs represented a quick way to break into e-cigarettes, especially considering Altria’s struggle to get their own vaping product called iQoS approved in America.

altria share performance

Source: Bloomberg

The Evolution of the Smoking Industry

Vaping products like Juul and iQoS are gaining significant traction in the market. Juul has gained almost 75% of market share over the past 3 years, with 61% of that gain coming from the year of 2017 alone. They experienced a 600% surge in sales from 2016 into 2017, posting a $1.5 billion revenue metric for 2017.

juul

Source: Bloomberg

The FDA Crackdown: The Uncertain Regulatory Environment

The FDA is Juul’s biggest hurdle. Juul’s product is extremely popular with youth, which is problematic for several reasons. The FDA shut down Juul’s headquarters and cracked down on distributors of the product. Juul stopped selling the fruitier flavors to stores, with the promise to utilize age-verification technology.  They also created a $30 million campaign to prevent youth from accessing the devices.

trends in vaping

Source: Mother Jones

The FDA will hold a hearing on January 19th, 2019 to discuss youth e-cigarette usage. This will determine the fate of Juul, as the FDA Commissioner has threatened to pull their products off the shelf entirely. Juul has spent a lot of time and money trying to convince regulators that the teen addiction was an accident, and that they didn’t purposefully target youth. They shut down their Instagram page, required models to be over the age of 35, and changed the names of their top flavors.

But now, getting into a partnership with Altria has changed all that. Altria has a long history with the FDA, and that experience should prove to be useful for Juul. Juul is giving Altria a whole new angle to target consumers.

The tobacco giant is starting to diversify its portfolio. Altria has several investment plans, including that of Cronos, a Canadian cannabis company.  Cronos gives Altria exposure to the marijuana market, which is slowly getting legalized in the US, and has the potential to be a promising industry.

The Promising But Uncertain Direction of the Cannabis Industry

Altria invested $1.8 billion (C$2.4 billion) for 45% ownership in Cronos, a Canadian cannabis company, paying a 40% premium on its most recent stock price. This comes on the tails of Constellation Brands $4 billion investment in Canopy Growth.

More and more people in the US are leaning towards the legalization of marijuana, with 2/3rds of Americans in support as of 2018. A provision for hemp legalization was within the 2018 Farm Bill. The passing of this bill could potentially take the cannabis industry to $20 billion by 2022, 2.5x growth from the current $800 million level.

legalize

Source: Politifact

It can also yield quite a bit of tax revenue for states, with Colorado raking in $247 million in 2017, a 27% increase from 2016 numbers. Colorado and Washington State have both exceeded the estimated tax revenues of cannbis, which is promising for continued growth. The Tax Foundation estimates that a “mature marijuana industry” could deliver $28 billion in tax revenues for federal, state, and local government.

ta revenues

Source: Bond Buyer

Cronos: Richly Traded, But With Good Debt Ratios

Cronos, Altria’s path into the cannabis industry, is currently trading around $10, which is $4 off year highs, with a market cap of $2.5B. The company is volatile, just like the cannabis industry that it operates in. Cronos posted a 32% gain over the course of 2018. In the graph below, which represents the change in share price on a percentage basis, Cronos is represented by the top orange line, and Altria by the green bottom line. Cronos has been volatile, but trending to the upside, whereas Altria has dipped,especially recently.

Charting Image Export - Dec 28th 2018 10_46_43 am

Source: Capital IQ

The injection of capital from Altria will help Cronos improve research and development, and expand across Canada. Altria has an abundance of resources for Cronos to pull from, including product development experience, as well as experience within the regulatory environment, offering similar opportunities to Cronos as they do to Juul.

Cronos is a richly traded company, with a PE ratio trading at 209x next years projected earnings. Their TEV / EBITDA is trading at an average of 102.52x, which is extremely high. For comparison, their closest competitor Aphria is trading at 36.49x TEV / EBITDA, and a PE ratio of 53.10.

However, Cronos has a current ratio of 9.0x for 2018, which means that they are more than able to cover any debt obligations that could come through. They have an extremely low debt to equity ratio as well. They might be expensive, but they are not at risk for insolvency, which is good.

Regardless, Cronos would be a small piece of Altria’s overall pie. Altria earned $19.5 billion in revenue in 2018. Cronos earned $C 11.7 million, which translates to approximately $8.5 million American dollars. They would have to make at least just under $1 billion to even represent 5% of Altria’s total revenue.

Conclusion

Altria is currently trading around $49 a share, dropping 25% since November. The company has not seen any improvement since the announcement of either the Juul or Cronos investments, most likely due to the uncertainty that surrounds both companies.

Altria is making a big bet that might not pan out. If the FDA decides to completely shut down the e-cigarette industry, which it has threatened to do, Altria just threw $12.8 billion down the drain into Juul. However, given the powerful political stance of Altria, it is doubtful that the investment will net zero. After all, Altria has “years of experience and literally hundreds if not thousands of interactions with the F.D.A. that (they’d) be happy to provide perspective on,” according to Altria CEO Howard Willard.

Cannabis is a growing industry, with a lot of potential, but it is dependent on legalization. Cronos might not have been the best cannabis company to invest in, but the fact that Altria is diversifying in that direction is promising. If the process of legalization continues in the US, which it should, Altria has the ability to benefit from Cronos.

Both investments provide for relative uncertainty, but on the whole, they are promising, from a quantitative perspective. Analyzing a company that produces a product as controversial as cigarettes is morally a challenge, but with Altria down 32.5% from 52-week highs, and trading at a PE ratio of 8.69, it is an interesting investment. The company has a high return on equity at 77%, and solid gross margins. They have been slowly decreasing their debt to equity, and paying attention to the direction that the industry is going in. If the two investments pan out, Altria has quite a bit of room to the upside.

Disclaimer: These views are not investment advice, and should not be interpreted as such. These views are my own, and do not represent my employer. Trading has risk. Big risk. Make sure that you can balance your risk/reward, and trade small, and trade often.

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