It's hard to find much fault with the performance of tobacco giant Altria Group (NYSE: MO) in 2016, as the cigarette stock has climbed double-digit percentages over the course of the year. Yet there are always things that companies can improve on, and in Altria's case, it has been interesting to see how it has dealt with the rise of interest in alternatives to traditional cigarettes. In particular, even former subsidiary Philip Morris International (NYSE: PM) has been far more aggressive about stating its commitment to reduced-risk products than Altria has, with the global tobacco giant going so far as to say that it can envision a world in which traditional cigarettes will disappear entirely. It's easy to understand why Altria hasn't been quite as outspoken about its stance on cigarette alternatives, but if you believe that the long-term future of smoking is in doubt, then it's disappointing not to see Altria take a stronger position in helping to push the industry forward. Let's look more closely at this issue to see how Altria can improve in 2017 and beyond.
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Philip Morris International has an aggressive view of how reduced-risk product portfolios will work. Image source: Philip Morris.
The death of cigarettes?
In November, Philip Morris CEO Andre Calantzopoulos made a bold statement. "I believe there will come a moment in time," Calantzopoulos said, "where I would say we have sufficient adoption of these alternative products to start envisaging ... a phase-out period for cigarettes." Moreover, the CEO stated his belief that that moment should come sooner rather than later.
One reason why Philip Morris has been so outspoken about reduced-risk products is that it has achieved impressive early success with the products. Early testing of its iQOS heat-not-burn technology and its related HeatSticks tobacco product has been extremely encouraging. In Japan, market share has reached mid-single digits in just a couple of years since its initial adoption. Test markets in Europe have also seen strong initial results, and Philip Morris has responded by working to build up its manufacturing capacity to meet the extremely high demand for iQOS systems and HeatSticks.
Indeed, Philip Morris is even working toward getting U.S. approval from the Food and Drug Administration for iQOS. That is likely to be a long process, but if it's successful, it could pay off in two ways. First, it will prove to the entire world market that iQOS has serious advantages over conventional cigarettes, further boosting demand and making it more likely that other government regulators will follow suit. Moreover, under the terms of its deal with Altria, Philip Morris should be able to get licensing revenue in exchange for the exclusive marketing arrangement that Altria will have for iQOS within the U.S. market.
Why isn't Altria more excited about iQOS?
Yet in press releases concerning the reduced-risk product, Altria hasn't gone nearly as far to accentuate its future potential as Philip Morris has. In connection with the FDA application, for example, the only thing that Altria said was that it will have an exclusive license to sell the heated-tobacco product in the U.S. if it gains approval.
Altria executives have made general comments about reduced-risk products, but they suggest that the two companies aren't on the same page from a long-term strategic sense. At an industry conference in September, CFO Billy Gifford noted that while Altria is excited about having iQOS in its product portfolio, the company still has to be committed to its core cigarette business. In Gifford's words, "We really have to focus on our core premium tobacco businesses and grow those while using some of the funds that are generated from that growth to fund the innovative tobacco space."
CEO Marty Barrington has also been supportive but in a general sense. For instance, in October, the CEO said that "on the Altria side, what we have is our plans with respect to commercialization and branding and go-to-market and the like" for iQOS, assuming that Philip Morris' FDA application eventually gains approval.
Looking beyond cigarettes
Of course, Altria does have some other reduced-risk products of its own that it wants to highlight. The MarkTen XL product has gained substantial adoption, with a marketing effort that has put the full power of Altria's distribution network to use. Other ideas on the reduced-risk spectrum could also contribute to growth.
Nevertheless, Altria has been very careful to look pragmatic rather than visionary in its view of the balance in the revenue and profits that traditional tobacco generates compared to alternative products. That's smart in the short run, but the danger is that if the industry pushes forward more quickly, Altria will have to play catch-up in a way that might not lead to the best results for the Marlboro maker in the long run.
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