Despite a declining customer base and greater restrictions being placed on smoking in markets all around the globe, there is a convergence of events happening in 2018 that could make the year Philip Morris International's (NYSE: PM) best one yet.
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Let's take a closer look at why investors should be excited at what might transpire over the coming year.
First, the bad news
Although Philip Morris enjoyed a 3.5% increase in third-quarter revenue and a 3% rise in operating income, it suffered a 4% decline in cigarette shipment volumes across every market it operates in. It was able to revise its earnings guidance for the full year higher only because it's been able to increase prices virtually at will, just like every other tobacco giant.
The inelasticity of demand for cigarettes is obviously related to their addictive nature, which causes users to be willing to pay almost any price to smoke. Sure, tobacco companies are losing more smokers every year, and the exorbitant cost of cigarettes is an important motivation for many people who quit smoking, but smoking remains a very profitable business.
That's not much of a "bad news" item for investors when you think of it, but the global dwindling user base will eventually take its toll on earnings.
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Which leads to the good news...
This long-term trend has led Philip Morris and peers Altria (NYSE: MO) and British American Tobacco (NYSE: BTI) to explore what comes next for the industry, and they've hit on electronic cigarettes as the solution.
While the first-generation type of e-cig that uses a cigarette-like device that heats up a liquid to produce a vapor has proven popular, it's really the next-gen devices using heat-not-burn technology that will likely lead the industry into what Philip Morris calls the "smoke-free" future.
Philip Morris International, British American, and even Japan Tobacco have competing designs on the market, but the former is arguably the leader here with its iQOS device.
The global cigarette giant says Altria's Marlboro (which it sells internationally) is the best-selling brand in the world and accounts for 35% of its shipment volume. Starting a few years ago, the two agreed to collaborate on developing reduced-risk products, which has led to the iQOS being marketed under Altria's Marlboro brand as HeatSticks, though it also sells them as HEETS in some markets.
The iQOS heat-not-burn (HNB) e-cig has tremendously ramped up production and is taking a growing swath of share in the markets in which it is introduced. In Japan, for example, which has become something of a testing ground for e-cig innovations, HeatSticks' market share in the third quarter grew to 11.9%, up from 3.5% last year and 10% in the second quarter. Moreover, it commands more market share than any other brand of combustible cigarette Philip Morris sells in Japan and is the second-largest brand in the industry.
And even more good news
But what should help really move the market, and why the iQOS can be seen as being in the forefront, is that Philip Morris is trying to have the device introduced into the U.S. as a reduced-risk product.
The company has applications before the Food and Drug Administration to allow it to both market the product here as well as give it a reduced-risk classification. Particularly if it achieves the latter, it will garner a significant competitive advantage by getting the FDA to view its product as a safer, healthier alternative to cigarettes when the competition cannot.
The regulatory agency is reportedly reviewing the application right now with a determination expected very early in 2018; that would be perfect timing for a big marketing blitz.
Right now cigarette companies are advertising on TV for the first time in decades, but it's coming as the result of a federal court order that basically has the tobacco companies admitting cigarettes are deadly. The ads are going to run for a year, and if Philip Morris can then market its iQOS device as a better alternative, the opportunity to steal market share acreage would indeed be vast.
In short, the smoking industry has brought about its own decline but also its own resurrection. 2018 could be a turning point for all tobacco companies -- but it could be the best year yet for Philip Morris International.
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