SocGen downgrades European tobacco sector

Societe Generale strategists have downgraded the European tobacco sector to 'neutral' from 'overweight' as higher US regulatory risks combine with declining US Treasury bill yields.

On Friday the US Food & Drug Administration unexpectedly announced a new control policy to reduce nicotine in cigarettes to non-addictive levels.

SocGen noted that there was no new regulation, but rather a call for public consultation on various topics, each of which could take years.

"Of these topics, we believe the largest potential threat to the tobacco industry is the US regulator's intent to lower nicotine in combustible cigarettes to non-addictive levels, potentially leading to reduced smoking incidence and an acceleration of cigarette industry volume declines."

Analysts noted that tobacco has been a bond proxy, with its relative performance mainly driven by US Treasury swings over the past seven years, so with a target for the 10-year US bond yield to reach 3.2% by June 2018 from the current 2.3%, consumer staples and tobacco are expected to continue underperforming.

The downgrade on tobacco comes as the FDA announcement "is a source of uncertainty and should undermine the risk/reward profile of the sector".