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Philip Morris Bets on Heated Tobacco to Keep Things Rolling

By Nicholas Rossolillo - Oct 29, 2017 at 11:35AM

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Higher prices put the brakes on business, but new products are helping offset losses.

Philip Morris International (PM -0.26%) released results from its third quarter of 2017 to mixed reviews. While the stock is up double digits on the year, headwinds for the business put a pause on further share advances for now.

PM Chart

Data by YCharts.

Q3 by the numbers

Net revenue for the quarter, excluding excise taxes, was $7.5 billion, up 7% year over year. And year to date, net revenue excluding excise taxes is up 3.8%.

Earnings per share for the third quarter were $1.27, $0.02 higher than last year. Through the first three quarters of 2017, earnings per share are up 1.5%. Management also doled out a 2.9% dividend increase for an annualized dividend of $4.28 a share, good for a 4% yield as of this writing.

Management also gave some negative news for investors to mull over, though. Full-year earnings per share, previously anticipated to come in at $4.78 to $4.93, was revised down to $4.75 to $4.80. While lower than previously thought, it's still a 5.7% increase over 2016 at the low end of guidance.

New products offset traditional product declines

Philip Morris, along with other big tobacco companies, has been struggling with a shrinking customer base. Higher taxes, government scrutiny, and education campaigns have led many people around the world to quit smoking or find alternatives. For years Philip Morris' solution has been raising prices on cigarettes. This year has so far been a similar story.

Cigarette shipment volume is down by 4.1% and 7.6% for the quarter and for 2017 so far, respectively. The company reported declining shipments in Europe, stiff competition in Russia, and a steep increase in excise taxes in Saudi Arabia that effectively doubled the price per pack for leading the declines. Some headway was made to offset the drop with average cigarette price increases. That is reflected in net revenues only declining 3.6% and 4.5% for the quarter and the year, respectively.

Philip Morris IQOS system, pictured in white, consists of a holder, charger, and a heat stick used to inhale the vapor.

Philip Morris' new IQOS heated tobacco system. Image source: Philip Morris.

Something new is helping make up the difference this year, though. Sales of heated tobacco products, which heat tobacco in water to create a vapor, and according to Philip Morris, reduce the risks associated with inhaling combustible products, have increased dramatically. The company sold just over two billion units of its IQOS in 2016, primarily in Japan where it has been undergoing testing the last few years.

Total units sold have skyrocketed this year to 9.7 billion so far, with Japan again making up the bulk of sales. The product has been released in 30 countries, but it's still a small part of the company's overall business. Cigarette and heated tobacco units sales this year are over 208 billion, making IQOS less than 5% of total volume. However, thanks to the big year-over-year increase for that offering, total shipments were down by only 0.5% in the third quarter, a notable difference from the 4.1% drop when only factoring for cigarette sales.

What investors need to think about

IQOS potential looks promising on the surface. However, Philip Morris has been dealing with falling sales volumes for years, offset with higher prices for cigarettes. Heated tobacco has become a new solution to offset waning interest in cigarettes, but it thus far looks like a new alternative for current smokers more than it does a new growth opportunity for the company.

Those factors added up to a lackluster quarter for Philip Morris, and make the company a hard one to get too excited about.

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