The world's largest publicly owned maker of tobacco products announced via its website that it wants to exit the cigarette business. Philip Morris International (NYSE: PM), which has been under pressure from anti-smoking organizations and increased government regulations, has been working on "reduced-risk" alternatives to smoking, laying out plans to make that its sole business.
However, the strategy is more of a pivot than a total makeover. Here's what investors can expect going forward.
Tech comes to the tobacco industry
All sorts of industries -- from retail to finance to industrial manufacturing -- are getting disrupted by technology. Philip Morris, seller of brands like Marlboro, has decided to take a stab at disrupting itself rather than waiting for a new upstart or consumer preferences to do so. The company has spent years researching and publishing data on new reduced risk smoking alternatives.
The result is a portfolio of heated and vaporized tobacco systems utilizing a variety of methods that mimic a cigarette but don't produce smoke. According to studies and findings sponsored by the company, the products carry far fewer (but still some) health risks and side effects than traditional smoking because of the absence of harmful byproducts produced when incinerating tobacco.
Philip Morris' flagship product, initially launched in Japan and slowly getting approval in other countries, is the electronically heated tobacco delivery system known as IQOS. Not yet available in many markets, especially ones like the U.S. that have stiff regulations for the tobacco industry.
Philip Morris best-selling IQOS smokeless tobacco product. Image source: Philip Morris.
Despite its limited availability, IQOS has been off to the races. Through three out of four quarters reported for 2017, total heated tobacco units shipped were over 20.5 billion compared to only 3.7 billion during the same period in 2016. That's impressive growth, but the sales volumes are still insignificant compared to Philip Morris' overall business. Total units of cigarettes shipped in the same period were 565.6 billion, making heat-not-burn products a mere 3.5% of the total.
However, the rapid growth in smokeless tobacco has been enough to prompt Philip Morris to announce its goal to exit the cigarette business. The company stated, in true New Year's resolution-style, its intention to fully replace cigarette sales with its up-and-coming lower-risk brands like IQOS.
The real reason for change
Philip Morris hasn't provided a date or specific timeline for its transformation, and the company will continue marketing and selling cigarettes in the meantime. That has given anti-smoking organizations another reason to be critical of the cigarette manufacturing leader.
But that also means investors don't have to worry about uncertain results from a radical overhaul of the business. Many investors may have started worrying years ago, though. Philip Morris is interested in replacing cigarettes, because cigarette sales are already in decline. The reason? Better consumer education on health risks, increased government scrutiny and taxes, and higher prices driven by cigarette companies themselves trying to increase profits despite declining volumes.
To illustrate, Philip Morris' shipment of cigarettes fell 7.6% in the first three quarters of 2017. That's on top of a 4.1% and 1% decrease in 2016 and 2015, respectively. The company has been able to increase revenue anyways by using price hikes, but the trend is obviously an unsustainable one in the long-term.
When looking at the numbers, this recent declaration from Philip Morris looks more like an attempt to stay ahead of the curve, rather than a revolutionary change in thinking about smoking. Big tobacco is a business after all, and sales and profits matter first and foremost, whether for better or for worse.
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