Regulatory controls are a normal part of business for tobacco companies. The primary legislator in the United States is the Food and Drug Administration (FDA). This protector of consumer rights seeks to shield individuals from the harmful effects of smoking. A looming law aims to include nine graphic advertisements on cigarette packages by the fall of 2012. This law, which was passed in June 2011, is particularly displeasing to tobacco companies because it is the most severe anti-smoking campaign in 25 years. Needless to say, this scenario is not being well received by the tobacco manufacturers or investors seeking to increase their shareholder value in these so called "sin" stocks.

Nine new graphic ads that depict the dangers of smoking were slated to be included on all cigarette packages in the United States by the fall of 2012. The FDA passed the law in 2009, and it signals the first drastic change to tobacco packaging laws in 25 years. The images are disturbing, to say the least. They include a corpse on an autopsy table and cigarette smoke coming out of the tracheotomy hole of a man’s neck. Some of the pictures are scientific in nature, such as one pair of smoker’s lungs alongside a pair of healthy lungs, while others are intended for shock-value purposes. The images will be situated on 50% of the top half of the front and back of a cigarette pack, and a national quit smoking hotline number will be included as well. In addition, the labels are required to be in at least 20% of any ad campaign.

The FDA devised a well-thought-out strategy before imposing the law. In November, it posted 36 images pertaining to the consequences of smoking, and welcomed public comment. They then used the comments and scientific literature to narrow the image set to nine. The intended impact, as cited by FDA Commissioner Margaret A. Hamburg, M.D., is to give smokers the incentive to quit as well as to dissuade first-time, or potential, users from taking up the habit at all.

But the law is an imposition about which the tobacco companies are not enthused. Cigarette manufacturers, such as Altria Group, Inc. (MO) and Lorillard, Inc. (LO) spend significant amounts of money on advertising campaigns each year, in addition to the millions that they pump into their research pipelines. Moreover, the billions that the tobacco industry earns each year are hit with high taxes, too. And the growing sentiment among tobacco companies and advocates for smoking is that the new proposed law infringes on the First Amendment Act that promises ``Freedom of Speech’’ because the tobacco companies feel their own message will end up getting lost due to the prominence of anti-smoking advertising on their products.

And, to say that tobacco manufacturers were taking the law in stride would be an exaggeration.  A group of five companies, including Lorillard and R.J. Reynolds Tobacco Company, a subsidiary of Reynolds American (RAI), filed a complaint against the FDA in November 2011 in U.S. District Court. The judge presiding over the case has agreed to allow the plaintiffs’ concerns to be vocalized because the magnitude of the ads seemingly does not serve to protect consumer interests, but instead, infringe on the aforementioned Constitutional freedom. At present, the tobacco companies seem to have been successful in at least delaying this law because it will not be able to be enforced until fifteen months after the issue has been resolved, either in or out of court.

Constant regulatory laws such as the aforementioned one could potentially curtail top- and bottom-line growth, a bit, but we are not too worried, at the moment. Indeed, other countries, such as Brazil and the United Kingdom, have had graphic images on their cigarette packages for a number of years. While smoking has declined in these countries, the decrease cannot be solely attributed to these campaigns. Higher prices, health awareness and better support groups that help individuals kick the habit are all more likely candidates for causing the steady decline.

Although litigation risks and the likelihood of stricter regulations are common to the tobacco industry, business prospects remain solid, in our view. Higher pricing, new products, and greater exposure to emerging markets will likely aid to offset restrictive laws. Moreover, although this new law (if passed) may cause some smokers to quit, new marketing strategies implemented by tobacco manufacturers will likely help to mitigate the impact.

At the time of this article’s writing, the author did not have positions in any of the companies mentioned.