An Altria Stake in ‘It’ Brand Juul the Right Move, Analysts Say

(Bloomberg) -- Reports of Altria Group Inc. talking to Juul Labs Inc. about a large minority stake surprised some, but not all analysts. Still, the prospect is being met with cheers by Wall Street and shares of Altria rose as much as 1.2 percent in early trading, adding to gains seen late in Wednesday’s session.

Juul is the leading “vape” brand and appeals to a younger demographic than Philip Morris International Inc.’s tobacco-heating system IQOS, analysts point out. The Juul is seen as a major contributor to the shrinking combustible cigarette market. Stifel analyst Christopher Growe writes, that “Juul’s growth has been substantial in the past two years, and this has clearly weakened the conditions in the cigarette category, leading to a 70bps hit to industry volume over the past year, by our estimate, and an even greater level of drag on industry volume in recent periods.”

Analysts believe a potential investment is “do-able” given Altria’s strong balance sheet and free cash flow generation. One question that has come up is what an investment in Juul may mean for IQOS and for Altria’s IQOS partnership with Philip Morris.

Here’s what Wall Street analysts are saying:

Wells Fargo, Bonnie Herzog

"This would be the absolute right decision for MO given where we think the reduced risk industry is heading & because Juul is the ‘IT’ brand," and the fastest growing e-cig brand in the U.S. (+940% y/y).

Altria could be investing $4 billion to $7 billion to acquire a 30 percent to 40 percent stake, based on an estimated $15 billion to $16 billion valuation of Juul, Herzog says, adding that she estimates Juul’s annual revenue to be approximately $2 billion.

While a stake in Juul would help to "round out" Altria’s reduced-risk portfolio strategy, as Juul seems to appeal more to millennials/hipsters and IQOS to slightly older, more affluent smokers, Herzog does wonder if there could be some risk in Altria de-emphasizing IQOS with the potential Juul stake, "although we’d like to think this would not be the case."

Rates outperform, price target $65.

Stifel, Christopher Growe

The stake would be "an abrupt reversal of the company’s attempt to build its own E-cigarette business under the MarkTen brand, in particular." That said, Juul would fit with Altria’s ultimate goal to dominate each category in which it competes.

The cost of a stake and the implied valuation level will be important considerations, Growe says. Juul has done a number of capital raises, and most recently it was "seemingly valued at roughly" $16 billion, but with FDA regulation coming forward since that time, "valuation has likely moved lower."

"We believe a stake in Juul would validate the E-cigarette category, which has pushed up pretty quickly to over 5% of total tobacco volumes" and would allow Altria "to capture consumers switching out of its tobacco categories into vapor as well as capture new consumers that were increasingly gravitating to Juul."

Rates buy, price target $70

Bernstein, Callum Elliott

"MO’s failure to embrace the next-generation product (NGP) revolution underway in the tobacco space is one of the key overhangs for the stock." A Juul investment could transform Altria’s NGP prospects "in one fell swoop" and reports of an investment should be positively received.

Elliott estimates that Juul is currently valued at around $14 billion, down from about $15 billion earlier this year as recent FDA interventions in the U.S. vaping space are likely to hit Juul’s near-term revenue and profitability.

"This is yet another threat to" British American Tobacco’s U.S. business.

Rates market perform, price target $60.

Jefferies, Owen Bennett

"We would not be surprised" if the media speculation was true. "We have written before that Altria was likely to struggle in vapor due to an inferior portfolio."

"It would also give Juul some legitimacy, and sets it up to compete better for adult smokers in a regulated environment (Altria distribution and regulatory know-how)" and could help ease concerns around industry fragmentation.

"For us, it will be interesting what happens with Altria’s commitment to IQOS if this deal goes through."

"Does it now think vapor is the bigger opportunity in the U.S.?"

"If Altria really believes in IQOS, and is committed to giving it as much shelf space as possible, we would question the logic of taking a stake in a company that could be impacted by heated growth."

Rates Altria hold, price target $56.

Bloomberg Intelligence, Kenneth Shea

Altria’s reported pursuit "would make strategic sense"

That said, an investment does come with risks: "A Juul stake won’t be inexpensive, and potential growth will be restrained by regulatory scrutiny over flavors and distribution in markets beyond the U.S."

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