A dramatic decline in revenue — up to 50% by 2034 — could face tobacco manufacturers if the Food and Drug Administration succeeds in establishing significantly lower nicotine levels, particularly in traditional cigarettes.

Morgan Stanley analysts issued an “industry risk navigator” report in which they say the “impact of a ‘maximum nicotine’ policy on the U.S. tobacco industry is underappreciated in our view.”

“Reducing nicotine in cigarettes to non-addictive or minimally addictive levels, in our view, would be a potential game-changer for the U.S. industry,” according to the report.

With the lower nicotine levels, the tobacco industry could lose up to $165 billion in combined profits over the next 15 years even if manufacturers gain revenue from innovation nicotine products, such as electronic cigarettes, heat-not-burn traditional cigarettes and oral nicotine products.

The analysts project BAT taking up to a 13% decline to its $88 billion market capitalization, partially limited because just 40% of BAT’s profits come from the U.S.

By comparison, Altria could experience up to a 20% decline of its $92 billion market capitalization.

Morgan Stanley also downgraded the stock of British American Tobacco Plc to “underweight,” the same as Altria Group Inc.

Altria holds a 35% ownership stake in Juul Labs Inc., maker of top-selling e-cigarette Juul, which has a 74% market share. BAT’s U.S. subsidiary R.J. Reynolds Vapor Co. holds 13% of the market share with Vuse, according to Nielsen convenience store data. Altria is expected to gain sales from heat-not-burn traditional cigarette iQOS.

BAT’s 52-week share-price range is $30.67 on Dec. 27 to $55.77 on July 31. The share price closed Tuesday up 8 cents to $35.80.

Meanwhile, Altria’s 52-week share-price range is $42.40 on Jan. 24 to $66.04 on Nov. 9. The share price closed Tuesday down 73 cents to $50.12.

There are four major reasons for the share-price decline, according to the analysts: debt and slow de-leveraging; Juul market-share gains with traditional cigarette consumers; potential FDA regulation to limit or ban menthol traditional cigarettes; and continuing trends in fewer consumers smoking.

Lawsuits expected

Other analysts say tobacco manufacturers may be able to weather lower nicotine levels — at least in the short term — from smokers consuming additional cigarette sticks to gain the same level of nicotine.

The Morgan Stanley analysts base their forecast on an expectation the FDA will issue its proposed rule of nicotine levels in October, in part to comply with a potential federal court ruling expected at that time.

The FDA likely will face multiple lawsuits from tobacco manufacturers and anti-smoking groups on the tighter regulations.

On June 13, the FDA recommended that a federal court judge extend the agency’s timeline for tobacco manufacturers to comply with planned enhanced regulations. It wants 120 days following the judge’s final order.

The FDA chose in August 2017 to allow certain flavored electronic cigarettes and cigars to stay on the market for years without pursing FDA authorization or being reviewed by the agency, currently until 2022 for e-cigarettes and until 2021 for cigars.

In March 2018, a coalition of seven public health and medical groups sued the FDA to get it to speed up enforcement. On May 16, Judge Paul Grimm for the District of Maryland ordered the FDA and the health groups to submit within 30 days their plans for accelerating the review process.

The Morgan Stanley analysts say that any maximum nicotine regulation “is unlikely to come into force within the next 10-plus years ... far enough away to allow tobacco manufacturers to de-level their balance sheets, protect their dividends and pivot their businesses away from traditional cigarettes.”

Regardless of nicotine levels, the analysts project the number of U.S. adult smokers will drop from 34 million to 14 million by 2030.

Wells Fargo Securities analyst Bonnie Herzog has said that for all their buzz, e-cigarettes remain as just the fourth largest tobacco product with 4% of retail tobacco sales, compared with 83% for traditional cigarettes, 8% for chewing and smokeless tobacco and 5% for cigars.

Opportunity for 22nd Century?

BAT has stated its opposition — and staked its reputation — on calling enhanced FDA oversight of tobacco products “not justified or workable.”

The global manufacturer, which owns Winston-Salem-based Reynolds American Inc., strongly voiced its opinion in a March analyst presentation.

BAT’s stance covered the very-low-nicotine standards the FDA is pushing to achieve, as well as a proposed ban on menthol traditional cigarettes that former FDA Commissioner Dr. Scott Gottlieb had recommended and promoted for several months.

BAT said it “believes the FDA does not have the (congressional) authority to ban a category of product (in traditional markets) ... or reduce nicotine (levels) in tobacco products to zero.”

When it comes to very-low-nicotine cigarettes with 95% less nicotine than traditional cigarettes, the focus of 22nd Century Group Inc. and its Mocksville manufacturing plant, BAT said that “we told the FDA it would take 20 years to comply with such a standard.”

If the FDA is successful in implementing very-low-nicotine standards in traditional cigarettes, the end result could be 22nd Century having a sharp increase in revenue and a potential buyout by a global tobacco manufacturer.

In September 2017, BAT ended a low-nicotine traditional-cigarette development partnership with 22nd Century that had been worth $14 million over four years. According to 22nd Century, annual royalties from BAT were capped at $25 million.

The end of the BAT-22nd Century partnership came about two months after the FDA emphasized in July 2017 that it views very-low-nicotine traditional cigarettes as a viable strategy for reducing cigarette consumption.

Some anti-smoking advocates say smokers may go to a black market to buy cigarettes made outside the U.S. with current nicotine levels.

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rcraver@wsjournal.com 336-727-7376 @rcraverWSJ

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