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Will Regulatory Challenges Hold Back Philip Morris' Reduced-Risk Strategy?

By Dan Caplinger – Nov 23, 2016 at 5:27AM

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In its investor day presentations, the tobacco giant talked how regulation will affect its long-term strategic vision.

Nearly all of the success that Philip Morris International (PM 2.01%) has reaped over its history as an independent company has come from the traditional cigarette market. The strength of the Marlboro brand worldwide has been a key asset for the tobacco giant, and other cigarette brands have also contributed to its worldwide popularity. Yet Philip Morris is moving aggressively into the reduced-risk products space, which is an area in which regulatory frameworks haven't entirely caught up to where they are with regular cigarettes. At its recent investor day presentation, Philip Morris President of Reduced-Risk Products Miroslaw Zielinski gave an update on the regulatory situation with reduced-risk products right now and what it will need to do to keep moving forward with products like iQOS and other initiatives in the e-cigarette and e-vapor markets.

Image source: Philip Morris International.

Where things stand with regulation for Philip Morris

Zielinski started by noting that the current regulatory trends are encouraging. Philip Morris has been aggressive in its promotion of the underlying science of harm reduction, and that has led to greater understanding from government regulators that encouraging reduced-risk products might actually be in their best interest. Several markets are looking at reversing existing bans on e-cigarettes, and most importantly for Philip Morris and its iQOS reduced-risk offering, regulators are beginning to understand that products that heat tobacco rather than burning it are fundamentally different from traditional cigarettes. Already, in the European Union, products like iQOS HeatSticks have a separate category from other tobacco products.

Philip Morris acknowledges, however, that different markets have different attitudes toward reduced-risk products. Zielinski pointed to the U.K. as a progressive market in this respect, noting that scientists and public health institutions better recognize the value of harm reduction that reduced-risk products provide. Yet in other areas, e-cigarettes and smokeless tobacco products face outright bans. One key that Philip Morris sees as vital is demonstrating that the risks from inhaling combustible tobacco are separate from the risks associated with nicotine exposure.

Zielinski said that regulation should hold companies accountable for the reduced-risk claims they make, showing how confident Philip Morris is in its own products in the category. At the same time, the company also recognizes the public health concerns about e-cigarettes, especially in the area of keeping young people from becoming addicted to nicotine and in preventing former smokers from relapsing.

How money and regulation go together

Another challenge that Philip Morris faces is that the governments that regulate its products also have a financial interest in the situation through the excise tax revenue that they collect. The tobacco giant is fully aware of the fiscal impact that reduced-risk products could have on governments, and one of the reasons why Philip Morris has picked the launch markets it did for its iQOS heat-not-burn products is that the HeatSticks that iQOS uses are taxed under a new excise-tax category or as "other tobacco products" in those markets. In addition, Philip Morris has gone to extensive lengths to show to customs authorities that iQOS and HeatSticks are not cigarettes. The company has noted that many reduced-risk advocates believe that favorable tax treatment for the products would potentially serve the public-health interest of encouraging smokers of traditional cigarettes to switch to lower-risk alternatives.

The question that remains unanswered for now is how willing government entities will be to give up tax revenue even if Philip Morris can demonstrate the reduced-risk nature of the products. Some governments have directly tied excise taxes to the health impact of smoking, and so it would be logically consistent that those taxes should go down if an alternative product has a smaller impact. Yet the reality of the situation is that many governments are vulnerable fiscally if revenue from any source declines, even if a positive benefit occurs as a result. Philip Morris will have to lobby skillfully in order to walk that line and find a balance that both it and the governments it works with can accept.

Regular cigarettes are lucrative for Philip Morris, but it sees the long-term advantages of diversifying to present a broader portfolio of reduced-risk products as well. By being aware of the regulatory frameworks in place and taking steps to help them evolve, Philip Morris hopes to boost the reduced-risk part of its business dramatically in the near future.

Dan Caplinger has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. 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.

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