When given lemons, make lemonade; when confronted with declining numbers of customers, make a new product that reignites growth. The latter is what the cigarette industry in general and Philip Morris International (NYSE: PM) in particular are attempting with electronic cigarettes. And as the pace of technological development advances, the outlook continuously improves.
While most of 2017 was a period when the global tobacco titan executed on its plan, it's ending on a bit of a sour note that could cloud the coming year. Here's a look back at what went right for Philip Morris International over the last 12 months, and a look forward to what investors can expect next year.
The year of setting expectations
Philip Morris International set the stage in late 2016 to become the anti-cigarette cigarette company, by declaring the future to be "smoke-free" and submitting an application to the U.S. Food and Drug Administration to review its iQOS heat-not-burn electronic cigarette. Having done that, the company kicked off 2017 with an earnings report that showed the potential of its reduced-risk product portfolio: From 62 million units shipped in the same period in 2016, it catapulted to 3.7 billion units.
Such growth continued ramping up all year long. By the end of the third quarter, Philip Morris International had shipped over 20 billion units year to date, compared to 3.7 billion the year before.
It also filed its iQOS pre-market application with the FDA, which would allow it to sell the device in the U.S. without a reduced-risk designation. This was essentially a backup plan; the iQOS could still find a market even if it couldn't say it was a safer alternative than cigarettes.
Thanks to Philip Morris International's marketing agreements with former parent Altria (NYSE: MO), the latter company will market the iQOS under the Marlboro brand as HeatSticks.
Back door into the U.S.
Since it was spun off from Altria in 2008, the U.S. tobacco market has been shut off from Philip Morris International as it promoted Marlboro and various other brands to 180 markets worldwide.
But beginning in 2013, the two cigarette companies began collaborations on reduced-risk products that saw Philip Morris International introduce the iQOS into a number of countries under the Marlboro brand. Most significant has been in Japan; the iQOS has quickly become one of the leading products for Philip Morris, accounting for 40% of its shipments to the country. In the third quarter, iQOS shipments surpassed combustible cigarettes for the first time.
But the device also gives it an entry point back into the U.S. If it can sell the heat-not-burn device through Altria, with or without a reduced-risk designation, Philip Morris International will have a toehold in the U.S. market once more; this would further spur speculation that it will combine with Altria once again.
There are good arguments against a merger, such as investors enjoying the bright-line separation between domestic and international risks. But a combination would help offset Philip Morris' currency risks, which will become more pronounced as interest rates rise in the U.S.
Ending on a down note?
Philip Morris furthered its cause for a smoke-free future by committing to seed $1 billion to the Foundation for a Smoke-Free World, which it created to educate on the benefits of smoking alternatives. Unfortunately, while the message may be sincere, many skeptics view the effort as a wolf in sheep's clothing.
Furthermore, Reuters recently reported that many of the studies the tobacco company used to bolster its case for approval may not have been as rigorous as previously believed. Some researchers have backed away from their knowledge of the protocols, while other tests were reportedly compromised.
As the saying goes: Big, if true. Immediately, the tobacco company was hit with numerous class-action lawsuits, and its stock has fallen 4% since the news hit. And with the FDA scheduled to hear Philip Morris' case on its reduced-risk application at the end of January, this could jeopardize that hearing.
Certainly 2017 was a good year for Philip Morris International overall, as it staked out its position as a global leader in smoking alternatives, yet the significant doubts cast on the efficacy of its research have to cast a pall on its efforts. There is now more riding on the January hearings than ever before.
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