Why Philip Morris International's New Heated Products Will Do Better Than Its Last Attempt

Philip Morris and Altria are betting on heat-not-burn technology; whether it is a blockbuster or a flop, it has to do better than the Heatbar.

Feb 1, 2014 at 8:30AM

Philip Morris International (NYSE:PM) is coming out with new heated tobacco products that may provide a much-needed source of growth amid declining cigarette sales. Altria Group (NYSE:MO) licensed the products for distribution in the United States. However, Philip Morris has released heated products before, so investors are not sure if the new products will be a game-changer or another flop.

Philip Morris has tried this before
The key to developing a replacement for cigarettes is to make the new product taste and feel as close to a real cigarette as possible. It also has to be safer for the smoker than a regular cigarette. Philip Morris completely ignored these rules when it developed Heatbar, a "battery-powered plastic device about the size of a mobile phone" released in 2004. Users would insert a regular cigarette into the Heatbar, which would then heat the tobacco and deliver a flavored aerosol to the smoker.

Perform a Google image search for "heatbar" and you will understand why these things did not catch on. Not only do they look unappealing, the only benefit of the Heatbar is to reduce secondhand smoke -- not a good enough reason for consumers to adopt them or for governments to encourage them. As a result, Philip Morris quickly abandoned the Heatbar.

Can Philip Morris' new heated products beat the Heatbar?
Altria and Philip Morris are betting that the new heated products will outperform their predecessor. In exchange for the right to sell Philip Morris' heated tobacco products in the United States, Altria gave Philip Morris the right to sell its MarkTen cigarettes outside the United States.

Philip Morris' heated products are referred to as Platform 1 and Platform 2. Platform 1 is closest to commercialization, due out in 2015 after pilot tests are concluded in 2014. Like Heatbar, Platform 1 heats tobacco and delivers a cigarette flavor and nicotine, but -- unlike the Heatbar -- it does not produce smoke. In addition to being safer for the smoker, Platform 1 is "smaller, better designed, and less awkward looking" than the ill-fated Heatbar. 

Platform 1's initial trials are promising. Philip Morris conducted a month-long usage study and found that 30% of users adopted the product, and 54% said they intend to purchase it -- blowing away management's wildest expectations. The company is so excited about Platform 1's prospects that it accelerated the launch date to 2015, well ahead of the original 2016/2017 target date.

Furthermore, Philip Morris estimates that if the adoption rate of its heated products and e-cigarettes is 5% of the potential user base, it could add up to $1.2 billion to the bottom line -- a 9% increase in annual operating profit based on the company's last four quarters.

For it to achieve that success, however, Platform 2 will also have to be a hit product. Platform 2 is a low-smoke product with an internal heat source that smokers use a lighter to ignite. This functionality makes the experience of smoking a Platform 2 more like the real thing. This is similar to Reynolds American's Eclipse cigarette. Eclipse contains even more carcinogens than low-tar cigarettes already on the market and has not become one of Reynolds' major brands. It is not yet known how much Platform 2 differs from Eclipse, but Platform 1 has better prospects than either one.

Foolish takeaway
Like all tobacco companies, Philip Morris is scrambling to find a new source of growth to offset a secular decline in cigarette volume. While most companies are focused on the emerging e-cigarette market, Philip Morris is placing its bet on heated tobacco products. Altria, too, could use a lift from heat-not-burn products, given that its MarkTen e-cigarettes have yet to roll out nationally.

Based on management's comments, Platform 1 could be a hit with consumers. At the very least, it will outdo the Heatbar. However, despite decades of trying, no innovation in the tobacco industry has been more successful than the regular old cigarette. Investors should watch for confirmation of consumer adoption before factoring Platform 1 into Philip Morris' valuation.

Three stocks all dividend investors need
If you're looking for some long-term investing ideas, you're invited to check out The Motley Fool's brand-new special report, "The 3 Dow Stocks Dividend Investors Need." It's absolutely free, so simply click here now and get your copy today.

Ted Cooper has no position in any stocks mentioned. The Motley Fool owns shares of Philip Morris International. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

1 Key Step to Get Rich

Our mission at The Motley Fool is to help the world invest better. Whether that’s helping people overcome their fear of stocks all the way to offering clear and successful guidance on complicated-sounding options trades, we can help.

Feb 1, 2016 at 4:54PM

To be perfectly clear, this is not a get-rich action that my Foolish colleagues and I came up with. But we wouldn't argue with the approach.

A 2015 Business Insider article titled, "11 websites to bookmark if you want to get rich" rated The Motley Fool as the #1 place online to get smarter about investing.

"The Motley Fool aims to build a strong investment community, which it does by providing a variety of resources: the website, books, a newspaper column, a radio [show], and [newsletters]," wrote (the clearly insightful and talented) money reporter Kathleen Elkins. "This site has something for every type of investor, from basic lessons for beginners to investing commentary on mutual funds, stock sectors, and value for the more advanced."

Our mission at The Motley Fool is to help the world invest better, so it's nice to receive that kind of recognition. It lets us know we're doing our job.

Whether that's helping the entirely uninitiated overcome their fear of stocks all the way to offering clear and successful guidance on complicated-sounding options trades, we want to provide our readers with a boost to the next step on their journey to financial independence.

Articles and beyond

As Business Insider wrote, there are a number of resources available from the Fool for investors of all levels and styles.

In addition to the dozens of free articles we publish every day on our website, I want to highlight two must-see spots in your tour of fool.com.

For the beginning investor

Investing can seem like a Big Deal to those who have yet to buy their first stock. Many investment professionals try to infuse the conversation with jargon in order to deter individual investors from tackling it on their own (and to justify their often sky-high fees).

But the individual investor can beat the market. The real secret to investing is that it doesn't take tons of money, endless hours, or super-secret formulas that only experts possess.

That's why we created a best-selling guide that walks investors-to-be through everything they need to know to get started. And because we're so dedicated to our mission, we've made that available for free.

If you're just starting out (or want to help out someone who is), go to www.fool.com/beginners, drop in your email address, and you'll be able to instantly access the quick-read guide ... for free.

For the listener

Whether it's on the stationary exercise bike or during my daily commute, I spend a lot of time going nowhere. But I've found a way to make that time benefit me.

The Motley Fool offers five podcasts that I refer to as "binge-worthy financial information."

Motley Fool Money features a team of our analysts discussing the week's top business and investing stories, interviews, and an inside look at the stocks on our radar. It's also featured on several dozen radio stations across the country.

The hosts of Motley Fool Answers challenge the conventional wisdom on life's biggest financial issues to reveal what you really need to know to make smart money moves.

David Gardner, co-founder of The Motley Fool, is among the most respected and trusted sources on investing. And he's the host of Rule Breaker Investing, in which he shares his insights into today's most innovative and disruptive companies ... and how to profit from them.

Market Foolery is our daily look at stocks in the news, as well as the top business and investing stories.

And Industry Focus offers a deeper dive into a specific industry and the stories making headlines. Healthcare, technology, energy, consumer goods, and other industries take turns in the spotlight.

They're all informative, entertaining, and eminently listenable ... and I don't say that simply because the hosts all sit within a Nerf-gun shot of my desk. Rule Breaker Investing and Answers contain timeless advice, so you might want to go back to the beginning with those. The other three take their cues from the market, so you'll want to listen to the most recent first. All are available at www.fool.com/podcasts.

But wait, there's more

The book and the podcasts – both free ... both awesome – also come with an ongoing benefit. If you download the book, or if you enter your email address in the magical box at the podcasts page, you'll get ongoing market coverage sent straight to your inbox.

Investor Insights is valuable and enjoyable coverage of everything from macroeconomic events to investing strategies to our analyst's travels around the world to find the next big thing. Also free.

Get the book. Listen to a podcast. Sign up for Investor Insights. I'm not saying that any of those things will make you rich ... but Business Insider seems to think so.

Compare Brokers