Smokers Feel Heat but Not the Burn -- WSJ

This article is being republished as part of our daily reproduction of WSJ.com articles that also appeared in the U.S. print edition of The Wall Street Journal (August 7, 2017).

Big Tobacco is working on its next act, as cigarette sales decline around the world and once-breakneck growth from the first wave of e-cigarettes fades.

Three of the world's biggest tobacco firms are rolling out new, electronic tobacco-heating devices they say are healthier alternatives to traditional smoking, but feel more like puffing on a real cigarette. That is a sensation many smokers complain is missing from the wide array of electronic cigarettes currently on the market.

None of the new heat-not-burn devices -- which heat real tobacco instead of the nicotine concoction typical in most e-cigarettes -- are available yet in the U.S., but that may be changing soon.

Last month, the Food and Drug Administration indicated it would take a friendlier approach to cigarette alternatives as a mechanism to help smokers shift to safer options.

"In just the last few years, we've seen the advent and adoption of new product categories that may be able to deliver nicotine without having to burn tobacco," said FDA Commissioner Scott Gottlieb.

Philip Morris International Ltd. is seeking FDA approval for a heat-not-burn device called IQOS. Through a partnership with Philip Morris, Altria Group Inc. -- once part of the same company -- hopes to sell IQOS under the Marlboro brand in the U.S., one of the industry's most profitable markets. It also hopes to market the product as safer than cigarettes -- a health claim that must be approved by the FDA.

British American Tobacco PLC plans to apply next year for FDA approval to sell its tobacco-heating device, Glo.

Some early success overseas is raising hope among investors and analysts that the "heat-not-burn" category could give Philip Morris, BAT and others a fresh lease on life.

For years, cigarette makers have been able to raise prices to make up for falling volumes. But executives know that can't last forever, and big tobacco firms have been scrambling to come up with alternatives.

For Philip Morris, the stakes are high. Unlike rivals BAT and Japan Tobacco Inc., which have rolled out an array of cigarette alternatives, Philip Morris has directed most of its efforts at IQOS, opening dedicated stores in cities like London and Tokyo to sell the device.

Makers of heat-not-burn devices claim such products are healthier than cigarettes, but to a lesser extent than e-cigarettes. The e-cigarettes currently on the market typically heat a liquid to create a nicotine-laced, inhalable vapor. Tobacco firms have rolled out their own versions, including "cigalike" products that look like old-fashioned cigarettes. So have hundreds of smaller competitors, many of which have concentrated on bigger, refillable vaporizers.

These devices have spread quickly, but once-torrid sales growth has cooled recently. In 2014, U.S. e-cigarette sales grew 130% year-over-year, according to Euromonitor International, a market-research firm. Last year, growth was 21%.

The slowdown is partly the natural consequence of a maturing market. But safety worries and regulatory hurdles, particularly in the U.S., have also curbed sales.

Another big impediment: customer satisfaction. Some users complain they aren't getting their blast of nicotine fast enough, or miss a real cigarette's "throat hit" -- industry speak for what smokers say is the feeling of smoke traveling down the throat.

Philip Morris, BAT and Japan Tobacco are hoping they have solved the problem by going back to the tobacco leaf. Their devices heat -- instead of burn -- the ground leaf to deliver a nicotine vapor they say is safer than cigarettes. It also tastes and feels more like a real cigarette, these makers claim.

"The taste satisfaction is very important," said Philip Morris Chief Executive Andre Calantzopoulos. "The closer you are to this, the more chances you have to switch people."

BAT's Glo and Philip Morris's IQOS include a heating device for disposable, tobacco-packed "sticks" that look and feel like ordinary cigarettes. Japan Tobacco's Ploom Tech takes a more hybrid approach, using tobacco capsules through which vapor generated from liquid in a cartridge passes. BAT's iFuse, another hybrid device, heats a nicotine-containing liquid into an inhalable vapor, which then passes through a tobacco section.

BAT's U.S. business, Reynolds American, has for years sold Eclipse, but the product hasn't gained traction and has very limited distribution.

Philip Morris is ahead of the pack. The company sells IQOS in over 25 countries. In Japan -- where e-cigarette sales are heavily restricted -- IQOS has lured enough smokers since launching nationwide last summer to account for about 10% of the overall cigarette market, according to the company.

"They absolutely have a first-mover advantage," said Euromonitor analyst Shane MacGuill. The new product is also expected to bolster the bottom line. Piper Jaffray analyst Michael Lavery estimates IQOS profit margins currently run about 30% to 50% higher than regular cigarettes. He says IQOS could contribute 15% of Philip Morris's profit by 2019.

Shareholders have taken notice. Philip Morris's stock has outperformed rival BAT, largely because of the success of IQOS.

Euromonitor expects the heat-not-burn sector to bring in $15.4 billion by 2021, and constitute 45% of the tobacco-alternatives market, up from 17% last year. E-cigarettes are expected to shrink from 83% of the current tobacco-alternative market to 55%.

But sales of cigarette alternatives still pale in comparison to cigarettes. Euromonitor expects tobacco heated products and e-cigarettes to make up just 3% and 4% of total cigarette market -- excluding China -- by 2021.

A question mark still hangs over whether the products will get the green light in the U.S., while some are skeptical about their safety. A May study by Swiss researchers found that IQOS released some of the same cancer-causing chemicals found in traditional cigarettes. The authors have called for more independent research to evaluate IQOS's health effects. In response, Philip Morris in June wrote a letter to top officials at the three Swiss institutions questioning the researchers' methodology.

"We think heated tobacco products have huge potential in the future," said Ian Jones, Japan Tobacco's vice president of reduced risk products. "But there's still some huge unknown questions that need to be looked at."

--Jennifer Maloney contributed to this article.

Write to Saabira Chaudhuri at saabira.chaudhuri@wsj.com

(END) Dow Jones Newswires

August 07, 2017 02:47 ET (06:47 GMT)