For Eaton Vance’s Metzold, the recent takeover buzz in the industry confirms to him that e-cigarettes are where the companies see their future, at least in the U.S market.
“Here’s your catalyst,” said Metzold, who sold all of his tobacco bonds more than a year ago. “Tobacco companies are buying the e-cigarette companies.”
Lorillard acquired blu for $135 million in 2012, and also bought the UK e-cigarette brand SKYCIG for $49 million. Reynolds began distributing Vuse e-cigarettes in June and the No.1 U.S. tobacco company, Altria Group Inc, is soon due to roll out its e-cig brand MarkTen nationally.
NOT EVERYONE’S A BELIEVER
Still, not everyone is convinced about the e-cigarettes boom and the likelihood of early default on the bonds.
“E-cigarettes are not a real replacement. They are another tool for people to quit smoking, but they are not a substitute. To me, it’s a fad,” said Dick Larkin, senior vice president and director of Credit Analysis, himself a smoker. “E-cigarettes are a threat to the MSA, but I don’t think they are a material threat.”
And the bonds are enticing for some, largely because they’re so cheap and offer juicy yields at a time when high rates of return in the fixed income market are relatively scarce.
Boston-based investment firm Loomis Sayles bought tobacco bonds several years ago when they were trading at deep discounts.
“I don’t think you can say with 100 percent certainty that e-cigarettes will supplant normal cigarettes. How does anyone even know that?” said Steven Bocamazo, credit research manager and senior research analyst at Loomis Sayles. “They have a small market share and, while growing, it isn’t the big threat that everyone is making it out to be.”
Tobacco-settlement debt currently counts among the highest-yielding in the municipal bond market.
The Standard & Poor’s Municipal Bond Tobacco Index sports an average yield to maturity of 6.24 percent for the $23.9 billion of bonds it tracks. By comparison, S&P’s index for general obligation muni bonds has a yield of just 2.9 percent.
But, even with a rally underway this year – the S&P tobacco bond index is up more than 13 percent – most continue to trade at distressed levels, reflecting their perceived default risk. Moody’s rates around 80 percent of all tobacco bonds at “B1” – which is four notches below investment grade – or lower.
“There are fund groups like ourselves, that said, ‘We don’t like what is going on here, we’re getting out,'” said Metzold.
SOME STATES SOFTEN THE BLOW
The softening revenue flowing to the bonds from weakening consumption trends has prompted some states to step in to support the bonds.
Earlier this month, New Jersey announced it would draw $12.5 million from reserves as a result of “insufficient tobacco settlement revenues” in April. Ohio and Virginia made similar announcements in May.
To further bolster payments, some Democrats in Congress want to fold e-cigarettes into the MSA, arguing the payments gives states “a powerful tool to stop e-cigarette makers from targeting youth.”
But many states haven’t spent the $100 billion received so far in tobacco settlement money on its intended use – to cover healthcare costs generated by smoking. Only 14.6 percent of the funding generated by tobacco settlement and state taxes are spent on causes recommended by the Centers for Disease Control and Prevention, the Campaign for Tobacco-Free Kids found.
Instead, states like New Jersey, New York and New Mexico have used some of the money to prop up general fund revenues or to service debt, among other things, according to the public policy group, State Budget Solutions.
Among state policy makers, the rise of e-cigarettes has caught the eyes of some but has not yet registered widely as a concern.
Spokespersons for California’s Department of Finance and New Jersey’s Treasury Department said they were monitoring the growth of e-cigarettes and both agreed it was “premature” to forecast how the new product would affect future MSA payments.
Kurt Kauffman, debt manager for the State of Ohio, said the state hadn’t “reached the point of concern yet.” Ohio expects to tap up to $31.5 million from a reserve account to cover a tobacco bond payment this year. “It’s something that we pay attention to and have an interest in following,” said Kauffman. (Reuters)