Philip Morris International's Bold Bet: Will Cigarettes Really Disappear?

By Markets Fool.com

Selling cigarettes propelled Philip Morris International (NYSE: PM) into an elite group of tobacco manufacturers worldwide. However, Philip Morris has worked hard on its efforts to create reduced-risk alternatives to traditional cigarettes, and company executives are even contemplating a future in which it no longer sells the regular cigarette products that have brought in billions of dollars over the years.

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Image source: Philip Morris International.

What Philip Morris International's CEO said

Philip Morris CEO Andre Calantzopoulos has been an outspoken proponent of reduced-risk products during his tenure at the tobacco giant. The company rolled out its iQOS heat-not-burn technology in the U.K., targeting the central London market, and Calantzopoulos gave a radio interview Wednesday with the British Broadcasting Corporation that showed the depth of his belief in the reduced-risk strategic direction that Philip Morris has taken.

Specifically, the Philip Morris CEO speculated that the maker of the highly popular Marlboro brand of cigarettes could do an about-face in its business model and turn entire toward reduced-risk products. "I believe there will come a moment in time where I would say we have sufficient adoption of these alternative products," Calantzopoulos said, "to start envisaging ... a phase-out period for cigarettes." The CEO added that he hopes that moment comes sooner rather than later.

Can iQOS crush cigarettes?

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From a business standpoint, Philip Morris has plenty of reason to make a push toward reduced-risk products. So far, it appears that the costs involved with producing iQOS units and the HeatSticks tobacco inserts that users need in order to use the device are consistent with what Philip Morris spends on regular cigarette production. For consumers, the purchase of the iQOS unit is an up-front cost, but the HeatSticks retail at prices that are in the ballpark of what one might expect to pay for a regular pack of cigarettes.

Meanwhile, early indications of potential health advantages of using heat-not-burn products rather than traditional cigarettes are encouraging. The company says that the heat-not-burn method produces only about 10% of the toxic materials that come from burning tobacco in a regular cigarette. The product still delivers nicotine to users, and health advocates are still uncomfortable with the idea that users could get hooked on reduced-risk products and then end up turning to traditional cigarettes thereafter. Yet Philip Morris has noted that the potential to convert existing smokers of traditional cigarettes toward using a reduced-risk product like iQOS is substantial. Already in its early rollout in the Japanese market, a majority of smokers who try iQOS stick with it, and that's far better than most of the competing e-cigarette products that used a liquefied nicotine chemical base rather than actual heated tobacco.

Is there a catch?

Some longtime anti-smoking advocates are skeptical about Philip Morris' claims and its motives for its recent moves. Many agree that if alternative products are shown actually to produce fewer negative health impacts, then it makes sense to encourage a switch away from regular cigarettes, given their impact on public health overall. Yet Philip Morris will always have to deal with criticism that research that it sponsors could inherently have a conflict of interest that could color its results, despite scientific ethics and other safeguards.

However, Philip Morris faces increasing regulation for traditional cigarettes around the world, with many countries not only following the lead of the U.S. but also taking things a step further, introducing plain packaging, large warnings, and other restrictions intended to discourage consumers from smoking. If Philip Morris can indeed come up with a solution that gives its customers the smoking experience they want while improving public health and answering the charges that government agencies and public health advocates have made for years, then it can only be good for the company's prospects for sales and earnings growth over the long run.

Smoking won't disappear overnight, and traditional cigarettes will always have a loyal customer base. However, by encouraging what could be a healthier alternative, Philip Morris is being realistic about needing to adapt to a world in which regular cigarette smoking will become less popular in the years and decades to come -- while still taking full advantage of the expertise and brand awareness it has built.

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