If you haven’t been paying attention to tobacco companies, you might not recognize the new landscape. On Tuesday, Philip Morris International announced it would invest $600 million to build a new production facility in Colorado for its popular Zyn oral nicotine pouch. The product went viral on social media earlier this year and is currently facing nationwide shortages due to capacity constraints. The news came on the heels of the announcement earlier this month by Reynolds American, a subsidiary of British American Tobacco , of its new nicotine-free, flavored vapor product, Sensa. The products are just two of many aimed at capturing current and former smokers — and make up for lost cigarette revenue. The alternatives also include heated tobacco and nicotine vapor products, although with the latter, tobacco companies face big competition from vaping companies and the proliferation of illicit vapes. “If you look broadly across the consumer, people are … changing how they consume things, changing the products they use,” said Brett Cooper. “Product evolution tends to be a bit slower in tobacco, but it’s part of the bigger mosaic of consumers changing what they want.” Confronting declining cigarette usage is nothing new for Big Tobacco. For instance, Philip Morris said cigarette shipment volume fell to 613 billion units in 2023 from 915 billion in 2011 — with an annual decline seen every year for the past decade. PM 1Y mountain Philip Morris’ one-year performance Countries around the globe have been working for years to reduce tobacco use. In 2013, the World Health Organization set a voluntary target of 30% relative reduction of tobacco use by 2025. By 2022, the projected relative reduction was 24.9%, the organization said in a report earlier this year. Philip Morris plans to ultimately replace cigarettes with smoke-free alternatives. At its 2023 investor day in September, the company announced it is aiming to have more than two-thirds of its net revenue come from smoke-free products by 2030. “I’m not saying that the combustible category will have disappeared everywhere in 10 or 20 years, but we are pretty sure that the smoke-free category [is] going to expand. There is no way back,” Philip Morris Chief Financial Officer Emmanuel Babeau said at a Deutsche Bank conference in June. What investors are watching and waiting to see is if the tobacco companies’ move to these reduced risk products, known as RRPs, can meaningfully replace revenue ultimately lost from cigarettes. The appeal of dividends Still, many investors who buy tobacco stocks are drawn by their attractive dividends. Philip Morris, for example, has a 4.84% dividend yield, Altria yields 7.95% and British American Tobacco yields 8.87%. Analysts don’t think those payouts are going away anytime soon. Jefferies analyst Owen Bennett believes the dividends can be sustained by the switch to RRP, although some companies are better placed than others. Cooper agrees. “[Philip Morris International is] far enough along in the journey to alternatives that I don’t see a risk to the dividend or dividend growth given that the alternatives are more profitable for PM than their core business,” he said. Altria, the parent of Philip Morris USA, may not be as far along as its competitor, but it also still has room to continue to pay dividends at this level or higher, he added. Navigating bans and illicit competition Smoke-free products aren’t without detractors. WHO’s campaign targets tobacco — both smoked and smokeless. The organization is also urging governments to use the same tobacco control measures on nicotine vapes, saying there is “alarming” evidence about the adverse effects. There are also concerns about the popularity of vapes — also called e-cigarettes — among underaged consumers, who are drawn to the flavors. In 2023, 4.6% of U.S. middle school students and 10% of those in high school used vapes, according to the Centers for Disease Control . The Food and Drug Administration has consistently denied approval of flavored vapes and has banned the sale of e-cigarettes that it has not authorized. However, experts say enforcement is difficult. States have also jumped on the bandwagon, with varying degrees of success. In July, the U.S. Supreme Court agreed to consider a challenge to the FDA’s refusal to approve flavored vapes brought by e-cigarette manufacturers. Those flavors include pistachio, pineapple and blueberry. One flavor the FDA has allowed is menthol, giving its first approval to a menthol e-cigarette in June. It also reversed its 2022 ban on Juul e-cigarettes the same month while it considers updated information and new court decisions. Vapes, which skyrocketed in popularity after coming on the scene in the mid-2000s, remain a go-to product. Global vapor retail sales grew by 54% to $35 billion in 2023, according to a UBS proprietary model estimate. Most of that came from companies in China, with tobacco companies only taking about 15% share, the bank said. “The WHO is also commanding ‘urgent action’ to control vapes. However, (i) bans are seldom effective, resulting in a grey/illicit market, (ii) Chinese manufacturers have been adept at navigating regulation, and, (iii) enforcement in complicated (e.g. there is a growing rey/illicit cigarette trade),” UBS analyst Faham Baig wrote in a June 14 note. Will tobacco stocks recover? There’s no question the popularity of vapes is accelerating the rate of cigarette volume decline. While some tobacco companies have their own vapor products and are trying to make inroads in the market, others are focusing elsewhere. “Companies are doing anything they possibly can to stay in business,” said investor Dan Ahrens, chief operating officer at AdvisorShares and author of the 2004 book, ” Investing in Vice .” One of the firm’s exchange-traded funds is Vice , which typically invests alcohol, gambling, video games, fast casual restaurants and tobacco stocks. “They are making more investments into the reduced risk products, but that’s a slow boat,” Ahrens said. “There’s no denying that the biggest percentage of revenues are still cigarettes, which is a slowly declining market.” These days he’s not overweight on tobacco stocks since the growth is expected to be slow, although he has a small position in British American Tobacco and a large one in small-cap name Turning Point Brands . Philip Morris International is among the names that Wall Street likes. The stock has an average rating of overweight and nearly 5% upside to the average price target, according to FactSet. Consumer Edge’s Cooper and Jefferies’ Bennett are both bullish. Cooper has an overweight rating, while Bennett rates it a buy. Philip Morris has bet big on not just its modern oral product, Zyn, but also its Iqos heated tobacco products and its vape product Veev One. While its second-quarter results are due on Tuesday, the company beat on both earnings and revenue for its first quarter. Overall, its smoke-free business accounted for 39% of its total net revenue in the first quarter. Units of its Iquos products, which was first launched in Japan in 2014, grew by 20.9% from the prior year to 31.1 billion in the quarter. Iquos is expected to start slowly hitting store shelves in select U.S. states. Heated tobacco hasn’t really seen regulatory roadblocks like those that vaping products have been facing and it is very profitable for Philip Morris, Bennett said. Meanwhile, its Zyn nicotine pouches grew 35.8% to 4.2 billion units. That growth was fueled by its popularity in the U.S., where shipment volumes grew 79.7% versus the prior year. “There is a lot of runway for growth for Zyn and nicotine pouches,” Cooper said. “There is a reasonably large disparity in segment development by state/region, which I think points to opportunity as the product gets more support and a higher level of consumer usage/word of mouth.” The new Colorado facility, coupled with a facility expansion already underway in Kentucky, should provide more than enough supply of Zyn going forward, Bennett said. He estimates total supply across both facilities could be up to 2.5 billion cans. Altria , which spun off Philip Morris International in 2008, has an average rating of hold and 2% downside to the average analyst price target. Under the separation agreement, Altria sells cigarette brands, like Marlboro, in the U.S., while Philip Morris sells them outside the U.S. MO 1Y mountain Altria’s one-year performance Cooper has an equal weight rating on the stock since it’s earlier in the alternative journey, he said. Bennett, however, has a buy rating on Altria. The company acquired NJoy, which makes nicotine vape products, last year. In April, it reported that NJoy’s retail share in the first quarter was 4.3%, a 0.6 market share point increase from the fourth quarter. Altria has been fighting against illicit vapes. It filed lawsuits in October against 34 foreign and domestic manufacturers, distributors and online retailers of illicit vapor products. “Today there are two markets — one for those who play by the rules and one for those who flagrantly ignore them. We are taking this action because the current state of the illicit e-vapor market is intolerable, and we must see more action from FDA and others,” the company’s executive vice president and general counsel, Murray Garnick, said in a statement at the time. Altria is set to report second-quarter earnings on July 31. Lastly, British American Tobacco has an average rating of overweight and 17% upside to the average analyst price target, per FactSet. Bennett is among those who rate it a buy. The company, based in London, has products in the vapor, tobacco heating and modern oral categories. BTI 1Y mountain British American Tobacco’s one-year performance Bennett is bullish on its newest nicotine-free vape Sensa. He believes it can support the company’s volumes by maintaining consumers that may want to quit nicotine altogether or add new customers who may like the flavors but don’t want nicotine. In addition, it could pave the way for moves into other areas, like caffeine, vitamins and melatonin, he said. “BAT has been very vocal about moves into ‘Beyond Nicotine,’ Bennett wrote in a July 1 note. “This would include using their oral and vaporizing technology for delivery of other active compounds.” That may also eventually include generic drugs, he added. In the end, Bennett believes the key to the rerating of tobacco stocks comes down to how successful they can be in harnessing these new products. He thinks it could happen. The first leg of this valuation reset will come when the market starts to get more conviction in RRPs and the second comes when investors realize volume declines during the transition are less pronounced than feared, he said. The third leg of growth will happen if the companies go beyond nicotine, he added. “I see huge upside in that,” Bennett said.