Philip Morris Is Finally Taking Its Cue From Reynolds and Lorillard

Philip Morris International (NYSE: PM  ) is seeing a lot of opportunity in e-cigarettes as sales of traditional cigarettes decline. According to Philip Morris, its six most important markets have seen 25% growth in e-cigarettes in the last two years. The company plans to enter the e-cigarette market with its current technology but with a view to deliver a better taste in late 2014.

The increasing consumption of e-cigarettes will exert great pressure on the top and bottom lines of all tobacco companies. Hence, it's no surprise that all major tobacco companies in the U.S. such as Reynolds American (NYSE: RAI  ) and Altria Group are also venturing into the e-cigarette market, which is currently dominated by Lorillard's (NYSE: LO  ) Blu brand of e-cigarettes.

E-cigarettes as a mechanism of nicotine delivery are becoming popular globally as they pose less health hazards compared to tobacco. The growth potential as of now is pretty huge, and Bloomberg Industries projects e-cigarette sales will pass traditional cigarette sales by 2047. Consumption is expected to grow 40%-50% in the coming year and could lead to a decline in traditional tobacco shipments.

Philip Morris wakes up
The decline in sales of traditional cigarettes has already begun, as seen in Philip Morris' third-quarter results. Cigarette shipment volume fell 5.7% to 223.1 billion units due to a sluggish tobacco industry, and the company reported a minuscule increase of 0.1% in revenue to $7.9 billion. On the back of a lower share count due to buybacks and positive pricing, adjusted earnings climbed 4.3% versus the year-ago period to $1.44 per share.

Philip Morris had a change of mind as far as e-cigarettes are concerned--the company was opposed to e-cigarettes earlier this year, but is now giving in. It is also looking to accelerate the launch of its reduced-risk products. This includes the development of a product that heats tobacco in cigarettes with a controlled heating mechanism. The company also plans to launch a product that heats tobacco instead of burning it in 2015, ahead of its previously expected launch between 2016 and 2017. These developments, along with the growing e-cigarette market, will be growth drivers in 2015 and beyond.

Philip Morris is looking at 2014 as an investment year. Also, it does not see industry volumes recovering until 2015. In 2014, it expects that overall international industry volumes will decline by 2% to 3%. It also expects currency-neutral earnings per share to climb by 6% to 8% in 2014, which is below the 10% adjusted growth expected this year and, as the company states, its 10% to 12% forecast going forward.

Philip Morris purchased a 20% interest in its Mexican tobacco business Grupo Carso for $703 million on Sept. 30. On the same date, it also signed an agreement to take a 49% stake in the United Arab Emirates company Arab Investors-TA. These two deals should start contributing to earnings from the fourth quarter onward.

Lorillard rules
Lorillard, in contrast, delivered an estimate-beating third quarter. Its revenue increased 10% versus the year-ago period to $1.8 billion as a result of strong sales of both electronic cigarettes and regular cigarettes. It reported adjusted earnings of $0.83 per share, which was 15.3% higher than the same quarter in the previous year.

It was an early mover in the e-cigarette market for which it acquired Blu in the spring of 2012. Since then, it has aggressively expanded the distribution channel for the Blu brand from 12,000 to 127,000 retail stores. As a result, it controls a 49% share of the U.S. electronic-cigarette market.

As competition is heating up in the e-cigarette market, Lorillard is stepping up its game by expanding into the U.K. e-cigarette market. In this case, it has also taken the acquisition route instead of reinventing the wheel. It has inked a deal to acquire SKYCIG, a leading premium brand of electronic cigarettes in the U.K.

Reynolds still behind
In comparison, Reynolds reported a mixed-bag of third-quarter results. Sales volume of traditional cigarettes dropped almost 4.3% as a result of tougher regulations and higher taxes that lead to higher prices, resulting in the growth of e-cigarettes. The company also lost 0.5% market share versus the year-ago period.

Reynolds American doesn't want to be left behind, and like its peers it is also venturing into the e-cigarette market. It expanded the distribution of its patented vapor-technology based e-cigarettes -- Vuse Solo and Vuse System -- in Colorado in July and is preparing for a nationwide roll out. But, in my opinion, until and unless Reynolds American starts gaining market share, it isn't worth investing in.

The bottom line
Philip Morris is finally venturing into the e-cigarette market after a different stance earlier this year. The e-cigarette market is growing, and Lorillard is making the most out of it, which is why investors should take a closer look at the company. On the other hand, once Philip Morris rolls out its own brand of e-cigarettes, it should start seeing growth once again.

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