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Morgan Stanley warns potential law changes could stub out half of British American Tobacco's US profits

US regulators are due to propose new laws later this year aimed at reducing the amount of nicotine in cigarettes, which would likely have a big effect on BAT’s profits
lucky strike cigarettes
The US is a huge profit centre for BAT

Shares in British American Tobacco PLC (LON:BATS) headed lower on Monday after Morgan Stanley warned potential law changes in the US could put a serious dent in future profits.

Shares were off almost 2% in morning trading to 2,831p.

READ: BAT on track to hit full-year targets

In October, the US Food and Drug Administration is due to set out new rules on limiting the amount of nicotine – the addictive substance – in cigarettes.

“Reducing nicotine in cigarettes to non-addictive or minimally addictive levels, in our view, would be a potential game changer for the US industry,” said Morgan Stanley in a note to clients.

“While a proposed rule is not an indication of the likelihood of a final rule, we believe this event may come as a negative catalyst for the Tobacco sector.”

Analysts reckon it will be at least ten years before any new regulation comes into force, but once it does, they believe profits in the US for the big cigarette makers – BAT included – could halve.

Even without any new laws, the chin scratchers estimate the numbers of smokers across the pond will plunge to just 14mln (from 34mln) by 2030, and any future rule changes will only compound that issue.

Market not pricing in potential law changes

Despite the huge potential effect on BAT’s bottom line, Morgan Stanley isn’t convinced that the market is pricing in the possible changes.

“We believe the high impact on future profits from a potential regulation change is not fully understood or appropriately reflected in BAT's share price,” Morgan Stanley's analysts said in a note to clients.

“In our scenario analysis we take a conservative stance on new regulation, assuming regulation to reduce nicotine to non-addictive levels takes until 2035 to come into force.

“However, even in this scenario we estimate that BAT's US profits could be as much as 50% lower and ~13% of future value at risk to the market cap.”

As a result, Morgan Stanley has cut its price target to 2,600p (from 2,750p) and downgraded its recommendation for the stock to ‘underweight’.

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