Philip Morris International, Inc.'s Best Move in 2016 So Far

Around the world, Philip Morris International (NYSE: PM) has a presence in selling tobacco products to dozens of different countries. The company has focused largely on cigarettes through its history both as a division of Altria (NYSE: MO) and as a separate and independent entity, and Philip Morris' access to the Marlboro brand has paid off among loyal customers. Yet more recently, Philip Morris has paid more attention to reduced-risk products, and the tobacco giant's moves to ramp up its tests of the iQOS heat-not-burn tobacco system have paid off with promising results. Moreover, the fact that Philip Morris and Altria have teamed up to share research on the alternative products front points to an even better future for both companies.

What Philip Morris has done with iQOS

Philip Morris International's efforts in the reduced-risk category started long ago, even though they're only just now starting to pay off significantly. In 2013, Philip Morris announced a partnership with Altria under which the two companies shared product licensing, scientific research, and other aspects of their alternative products businesses. Specifically, Altria gave Philip Morris an exclusive license to sell Altria e-vapor products internationally, while Philip Morris gave Altria U.S. rights to sell heated tobacco products. The collaboration also involved taking advantage of improvements for the joint benefit of both companies.

Last year, Philip Morris expanded its relationship with Altria. The new deal broadened the reach of the partnership to include the joint production of future e-cigarette brands, further cementing the idea that products other than traditional cigarettes offer the maximum potential for both companies.

Speeding up the rollout

Philip Morris began iQOS tests in limited markets, but the product has done so well that Philip Morris has accelerated its rollout. Now, the company has rolled out iQOS on a nationwide basis in Japan, where it has quickly picked up market share of 2.7% during the final week of June.

In addition to Japan, the ramp-up in Italy and Switzerland has gained momentum, and Philip Morris is seeing similar early results to what it experienced in the Japanese market. At the same time, Philip Morris has made iQOS available in Monaco, as well as select cities in Germany and Denmark. By the end of 2016, the tobacco giant expects to have launched the product line in roughly 20 different markets.

Perhaps most importantly, Philip Morris has seen favorable trends in terms of cannibalization of its other business. Early on, many investors feared that reduced-risk products like HeatSticks would only serve to lure away traditional smokers, resulting in no net change in customer appeal. Instead, what has happened is that there's been successively less cannibalization of traditional tobacco products and more people coming in either from other brands or directly as their first experience with Philip Morris products.

The biggest problem for Philip Morris with iQOS has been keeping up with demand. The company has had to manage its capacity to produce iQOS HeatSticks closely, as well as the supply of iQOS devices to let customers use the HeatSticks.

What's ahead for Philip Morris?

Some investors believe that the fact that Philip Morris and Altria are collaborating more extensively suggests that they should go a step further and merge back into a single entity. Admittedly, many of the reasons for the original 2008 spinoff have gone away. In the past, international regulation was far less extensive in most parts of the world than what the U.S. imposed, and so the spinoff was intended to give Philip Morris free reign and less potential liability than its U.S. counterpart. Now, though, many countries have followed the U.S. lead in putting further regulation on tobacco, and that makes the advantages for Philip Morris much smaller than they were in the past.

Given the size of the two companies, the chances of a combination are small. However, as long as the partnership continues to bear fruit, then the status quo should deliver solid results for Philip Morris. In addition, given how much potential iQOS has, Philip Morris shareholders might well want to keep all of their profit for themselves. That fact shows just how strong a move it was for Philip Morris to keep building on the partnership and make the most of opportunities that have arisen from it.

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