It's Time Philip Morris Bears Believed in Its Smoke-Free Future

Philip Morris International (NYSE: PM) is telling anyone who will listen that it really believes the future is smoke-free. The leading global cigarette manufacturer has invested billions of dollars in research and development on what it claims are reduced-risk products, such as its iQOS heat-not-burn electronic cigarettes. It's also created a foundation to promote alternatives to traditional cigarettes, pledging to contribute $1 billion to its efforts, and taken out full-page ads in newspapers declaring it wants to kick the cigarette habit itself.

Yet Philip Morris critics persist in being skeptical of its claims, including 10 U.S. senators who want the FDA to deny the company's application to sell the iQOS with a reduced-risk label. But maybe after the tobacco giant's fourth-quarter earnings results, the bears who disbelieve Philip Morris' claims of wanting to leave its cigarette past behind will come around to its way of thinking.

Change is coming

The tobacco leader reported its 2017 earnings earlier this month, which missed analyst expectations. Revenues for the year came in at $78.1 billion, up 4.2%, though after excluding excise taxes, they were just $28.7 billion, a 7.7% increase. Net profits, however, were $694 million for the quarter, down 60% from $1.7 billion in the year-ago quarter, or $1.31 per share on an adjusted basis. That was below analyst consensus forecasts of $1.35 per share.

While total shipments were down 2.7% from 2016, that was solely because cigarette shipments were down nearly 7%. Shipments of heated tobacco (which includes Philip Morris' iQOS device) surged nearly 400% year over year. Including all geographies, shipments of heated tobacco units hit 36.2 billion, up from almost 7.4 billion a year ago.

In the fourth quarter, Philip Morris shipped more than 15 billion iQOS devices -- meaning it shipped more next-gen cigarettes than it did long-established brands such as Chesterfield, Parliament, and its own Philip Morris cigarettes. In fact, only Marlboro and L&M brands shipped more.

Although that's still a fraction of the 762 billion cigarette shipments for the tobacco leader, it's clear Philip Morris is ramping up its smokeless alternatives, and sooner rather than later they will reach parity.

Already a leader

The iQOS is already Philip Morris' dominant device in Japan. For all of 2017, traditional cigarettes still eke out a lead over the heated-tobacco device, but in the fourth quarter, following a nationwide rollout of the iQOS, the heat-not-burn e-cig saw 13.1 billion units shipped for the period, compared to only 7.7 billion combustible cigarettes. Even though the Marlboro brand ended the year with an 8% share of the total market -- making it still the leading combustible-cigarette brand in Japan -- the iQOS HeatSticks had surged to a 13.1% share of the market. The heat-not-burn device is now Philip Morris' leading brand of all cigarette products.

The acceptance and proliferation of the iQOS has forced rival Japan Tobacco (NASDAQOTH: JAPAF) to announce it will release its own heat-not-burn cigarette later this year in a bid to stop Philip Morris from running over the market like a steamroller. It is promising to spend nearly $1 billion over the next few years on additional R&D of reduced-risk products.

You can see similar growth of the iQOS in other markets where Philip Morris has introduced the device, though they're not as pervasive as they are in Japan, which was the first country in which the product was released:

Kicking the habit

Philip Morris is increasingly proving its commitment to move away from combustible cigarettes and toward reduced-risk products. Other markets are openly embracing these devices as a safer alternative to smoking, even if they're not the healthiest solution (even Philip Morris now publicly states that the best solution is for smokers to not smoke anything).

It remains to be seen if the FDA allows Philip Morris International's marketing application for the iQOS, and though there is room for debate on whether it should garner a reduced-risk label, a number of other public agencies around the world have adopted these devices as a healthier alternative for smokers than if they continued smoking.

The bears had better start believing that Philip Morris is truly heralding a smoke-free future.

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Rich Duprey has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.