What Investors Need to Know From Philip Morris' New Tobacco Study

Image source: Philip Morris International.

Earlier this month, Philip Morris International (PM 2.82%) released the results from its new tobacco Reduced Risk Product scientific research. The new division, PMI Science, employs over 300 scientists to study the potential health risks of the company's new products aimed at making tobacco consumption less harmful. Why would a cigarette company conduct such a study, what were the findings from the study, and will the efforts help the company grow long-term?

The setup for the study

As the world's population grows, the number of smokers is expected to grow as well. According to the World Health Organization, there will be more than 1 billion smokers by the year 2025.

So why would Philip Morris, the company most famous for selling Marlboro outside the United States, be interested in studying tobacco alternatives? The company cites increasing regulatory efforts aimed at reducing smoking and educating people about the risks.

As a result of these increased regulatory efforts, even high-growth emerging markets have been slowing in recent years. Shipments of cigarettes in developed markets such as North America and Western Europe have been decreasing in the past few years. In fact, worldwide cigarette consumption broke a decades-long trend when use fell 1.8% in 2014, led by a surprise decrease in China.

For these reasons, Philip Morris is developing and studying a portfolio of alternatives. The company's report states the following:

Our objective is to replace cigarettes with RRPs as soon as possible. The scientific work we're conducting is at the heart of this transformation. Our approach is based on the acknowledgment that innovative products will benefit public health if they meet two conditions: first, they must significantly reduce risk of disease compared with cigarettes; and, second, they must be acceptable enough to smokers to encourage them to switch to such reduced-risk alternatives.

Basically, if you had any ideas that big tobacco has found a moral high ground, think again. These efforts are aimed at reducing tobacco use risks only if smokers want the new products, and only if the new products help get regulators out of the way. As a company with shareholders demanding ever increasing profits, though, such is the duty a company like Philip Morris has accepted.

The gist of the study

PMI Science starts by studying new products in laboratory settings and finishes with studies in the real world. The lab first demonstrates that the new product doesn't cause combustion of the tobacco or nicotine-containing material. The next step is to verify that the lack of combustion results in reduced levels of "harmful and potentially harmful compounds," or HPHCs. The last step is to conduct studies on how the consumers use the new products in the marketplace. These studies coincide with long-term clinical studies that attempt to find out if the new products reduce the health risks associated with traditional smoking.

To date, the company has developed two systems of nicotine delivery. The first are products that electrically heat tobacco, but not to the point that the tobacco reaches combustion. The second group consists of nicotine-containing but non-tobacco products that are heated and create a vapor.

A myriad of electronic nicotine delivery methods has been developed. Image source: US Food and Drug Administration.

What were the findings? Based on initial studies conducted in Japan and the United States, the company has found that smokers who switched to electrically heated products saw reduced exposure to HPHCs approaching, but typically not quite reaching, levels of exposure for those who quit using tobacco completely.

Philip Morris plans on submitting results to a scientific journal for peer review later this year as well as sponsor an expanded program of study measuring longer-term effects of switching to electrically heated products. The Investigator Initiated Studies Program has been launched as a pilot program, and company support is available for researchers interested.

Has Big Tobacco won a battle or the war?

Perhaps you're thinking that new smoking products will reinitiate a wave of growth for cigarette companies. Philip Morris studied that idea, too. When presented with cigarette alternative product messages, non-intended audiences (read: non-smokers) showed no interest in using the products. That would suggest that a new avenue for growth is not being developed here, since non-smokers aren't showing any new interest in starting with an alternative product.

How about the goal of getting regulators to relax? Recent history would suggest not so much. The electronic-cigarette industry was dealt a blow earlier this year, when the FDA levied new regulations in the United States that would give the power to control new products the same way cigarettes are. A spirited debate and a lawsuit against the FDA has ensued since.

As that conversation continues to unfold, it would at least initially indicate that new alternative products aren't Big Tobacco's silver bullet to regulation. Philip Morris has the advantage of not selling in the U.S., so the company hopes the new study will help get a jump on increased scrutiny in other markets, especially the all-important developing markets in Asia, the Middle East, and Eastern Europe.

A highlight from the company's second-quarter earnings was that electrically heated products in Japan have grown to own 2.2% of total smoking products market share. Shipped units increased to 1.6 billion, up from 56 million last year, indicating massive growth potential for the new alternative. However, total volume of cigarettes shipped so far this year is down 7.5% for Asia and down 3.2% worldwide from the first six months of 2015.

Rather than being an exciting new growth opportunity for investors to mull over, new reduced risk products are starting to look like a way for Big Tobacco to hold on to what it already has.