For decades, Philip Morris International (PM +6.98%) served smokers across the globe, first as the international division of its former corporate parent and more recently as an independent company. Cigarettes have produced billions of dollars in profits for Philip Morris and will continue to do so in the years to come.
Yet the company has also moved aggressively toward embracing reduced-risk products, and earlier this month, Philip Morris presented a sustainability report in which it gave its latest outline on its intended fundamental business transformation toward smoke-free products. The natural question many investors have is whether Philip Morris is sincere about these efforts, and whether the company is endangering the cash cow that has driven its success throughout its history.
How Philip Morris is positioning itself for a smoke-free world
Philip Morris' sustainability report didn't mince words about its core business. Consider the following quotes:
- "There is no doubt that the greatest contribution PMI can make to society is to replace cigarettes with less harmful alternatives."
- "Smoking cigarettes causes serious disease, and the best way to avoid the harms of smoking is never to start, or to quit."
- "We are now focusing our efforts to transform our company from a cigarette maker to a smoke-free technology leader."
- "We have reallocated a very significant part of our company's resources to make our vision of a smoke-free world a reality."
These words would have sounded like a death knell for the tobacco giant in the past. Yet Philip Morris believes that the answer for the 1.1 billion people around the world who smoke is to embrace smoke-free alternatives. According to the company's research, even though nicotine is addictive, the principal problem that causes adverse health impacts is the smoke generated by burning tobacco. Philip Morris believes that it can come up with alternatives that avoid tobacco combustion, but still provide an experience that's enjoyable for smokers.
Already, Philip Morris has seen substantial success on this front. The iQOS heated tobacco product is available in more than 25 countries, and more than three million people have stopped smoking cigarettes and switched to iQOS. Philip Morris estimates that another 8,000 smokers are making the switch every day. With plans to invest in four factories throughout Europe to boost manufacturing capacity for iQOS heated-tobacco units, Philip Morris sees a promising future for the device.
Image source: Philip Morris International.
An extended timeline for change
Philip Morris International doesn't expect these changes to happen overnight. Gradual change will be necessary, but the company has already made substantial progress. Philip Morris expects net revenue from smoke-free sources to top 10% of its total sales in 2017, up from just 0.2% in 2015. By 2025, the tobacco giant hopes to have shipment volumes of smoke-free products up to 250 billion units, while traditional cigarette shipments will fall by another third, to 550 billion units. That will leave the company still highly dependent on cigarettes for the foreseeable future, but it will make Philip Morris' trajectory clear.
Philip Morris recognizes that some will be skeptical about its motives, but it insists that its objective is to reach a smoke-free future as soon as possible. Yet in the words of CEO Andre Calantzopoulos: "We cannot achieve this alone. It also depends on a number of factors out of our direct control, mainly support from regulatory and public health authorities, that will influence the pace and scale of switching."
Moreover, Philip Morris knows that it can't single-handedly change culture. The CEO acknowledged that, as long as there's demand for traditional cigarettes, there will be suppliers willing to sell cigarettes to them. Nevertheless, Philip Morris is confident that as scientific research bears out the advantages of smoke-free products compared to cigarettes, more people will be willing to make the shift.
Keep your eye on Philip Morris
Philip Morris has seen dramatic success from its initiatives to shift toward reduced-risk products like the iQOS heated tobacco system, and it intends to build on its initial momentum toward the new products. Having established that alternatives to traditional cigarettes can be both popular and profitable, there's no reason Philip Morris wouldn't want to be the first mover in a direction that most see as inevitable in the long run.
