Can E-Cigarettes Save Philip Morris International?

Philip Morris International (NYSE: PM  ) has been one of the worst-performing stocks in the S&P 500 over the past week, with shares of the tobacco giant down more than 7% in light of pessimistic comments the company made about its future prospects. Yet Philip Morris has also said it plans next year to enter the e-cigarette market, a segment that has helped domestic counterpart Lorillard (NYSE: LO  ) find growth in a sluggish U.S. tobacco market and has inspired rivals Altria Group (NYSE: MO  ) and Reynolds American (NYSE: RAI  ) to explore electronic cigarette products of their own. Can e-cigarettes help Philip Morris get out of its funk? Let's look more closely at Philip Morris and how it's positioning itself for the years to come.

A smaller world after all?
Ever since its earnings release back in October, Philip Morris has been less than upbeat about its future. Despite reporting earnings growth from the year-ago quarter, the tobacco company cut its guidance for the current year, citing weakness in some key markets and some one-time factors that likely won't repeat. Interestingly, international demand was far weaker than what most domestic producers saw, as the 5.7% drop in cigarette volumes Philip Morris suffered during the quarter was worse than Reynolds American's 4.3% drop, let alone the volume gains that Altria and Lorillard reported.

Those woes continued last week, when Philip Morris said that profit growth would slow in 2014 to 6%-8%, below its 10%-12% growth target. Volumes could drop another 2%-3% worldwide, with Russia and the European Union being substantial sources of weakness. Moreover, those estimates exclude currency impacts, and a strong dollar could hurt Philip Morris' results even more.

One big problem that Philip Morris has faced is increasing regulation on the international front. For years, investors preferred Philip Morris, with its large international exposure, precisely because U.S. regulation was so harsh compared to conditions across the globe. But recently, Europe imposed much stricter limitations on cigarettes, forcing larger warning labels that will eliminate much of the advantage that Philip Morris and its fellow overseas peers had against Altria, Lorillard, and Reynolds American in the U.S. market.

E-cigs to the rescue?
But Philip Morris doesn't intend to give up without a fight, and it has finally decided to jump on the electronic cigarettes bandwagon. Philip Morris will introduce its own e-cigarette next year, hoping to capitalize on the growth that the market has seen in the U.S. and to export the concept around the world.

Lorillard has seen great success with its blu eCigs brand, prompting even recalcitrant Altria to buy into the industry. What many companies first saw as needless cannibalization of their own tobacco dominance has turned into recognition that a combination of regulation and changing consumer perceptions of tobacco require the about-face in strategy. Philip Morris hopes that the trend will catch on as well abroad as it has domestically.


How e-cigarettes work. Source: Blu Cigs Wiki.

Electronic cigarettes haven't been through the regulatory wringer yet, though, which poses a long-term threat to their attractiveness. Moreover, if revenue-hungry governments see customers substituting untaxed or low-tax e-cigarettes for heavily taxed tobacco products, they might be eager to replace their revenue by imposing taxes on the products. Already, some U.S. colleges have updated smoking policies to ban e-cigarettes, and the FDA faces substantial pressure to regulate them in the same way as tobacco. If international regulators follow suit, they could kill Philip Morris' strategy even before it launches.

Despite looming threats, Philip Morris International won't see its conventional tobacco business evaporate overnight, and e-cigarettes might not prove to be the answer to its regulatory and growth concerns. By seeking all alternatives, though, Philip Morris can ensure it won't get left behind if the electronic-cigarette revolution does take off.

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11/21/2014 4:01 PM
PM $87.00 Up +1.19 +1.39%
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MO $49.24 Up +0.41 +0.84%
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