Philip Morris International (PM 0.31%) is a key player in the global tobacco industry, and it is driving a revolution away from traditional cigarettes toward alternatives that it hopes will be equally satisfying to customers while addressing some of the health concerns that regulators and consumer advocates have had for years. Following the company's most recent earnings report, Philip Morris CFO Jacek Olczak made comments about the results. By looking at them, you can get a better sense of what Philip Morris sees as its long-term strategy.
1. iQOS is the growth driver for Philip Morris
To date, we have launched iQOS in key cities in 31 markets, and more than 3.7 million adult consumers have already stopped smoking and switched to iQOS.
Philip Morris is betting its future on reduced-risk products like the iQOS heated tobacco system, and so far, that bet appears to be paying off. After facing supply constraints, the tobacco giant is finally supplying the island nation of Japan with all of the HeatSticks it needs. The impact has been impressive, with HeatSticks' market share having more than tripled to 11.9%. HeatSticks is now Philip Morris' largest brand in Japan, and it makes up about a third of the company's overall market share there. Korea has seen market share hit 2.5% for iQOS-compatible tobacco sales despite more limited distribution, and although figures are more modest in European markets, the future for iQOS looks bright around the world as Philip Morris bulks up its capacity.
Image source: Philip Morris International.
2. Why a stronger euro hasn't helped Philip Morris as much as some would think
Our guidance also now includes approximately $0.17 of unfavorable currency compared to $0.14 previously, due principally to the Egyptian pound.
Philip Morris has dealt with a strong dollar for years, and investors had hoped that when the euro began to gain ground against the greenback, the tobacco giant's results would finally start to rebound. Yet what those following the company hadn't realized was that Philip Morris' exposure to foreign exchange goes well beyond the most followed currencies in the world. Even as the euro has done well, currencies like the Russian ruble and Egyptian pound follow their own trajectories, and when they're weak, Philip Morris will still feel the brunt hit to its top and bottom lines.
3. Philip Morris has seen difficult times in key markets
In Saudi Arabia, the significant excise tax increase in June, which resulted in the doubling of retail prices, is currently driving higher-than-anticipated declines in cigarette industry volume, especially in the highly profitable premium segment, where Marlboro is the leading brand. In Russia, cigarette industry volume is also softer than expected, while net pricing in the market remains constrained by the competitive environment.
One thing investors have to remember about Philip Morris is that in some ways, it's a conglomeration of dozens of different businesses that sell cigarettes and other tobacco products in very different national markets. Differing levels of regulation, taxation, and demand create a wide array of business conditions that Philip Morris has to consider in coming up with a broad-based business strategy. This quarter, Russia and Saudi Arabia were key flash points, but those focus areas change from period to period, and it takes many investors a while to get a feel for where Philip Morris needs to perform the best.
4. Philip Morris is reorganizing
The management changes and new geography segmentation announced on Sept. 28 [are] intended to drive the company's transformation toward a smoke-free future while maintaining its financial performance. These changes should enable faster decision-making and a greater focus on both parts of our business.
Philip Morris has until now had four geographical regions, reflecting the Americas, the European Union, Eastern Europe and surrounding areas, and Asia. With iQOS ramping up in Asia, the company decided to split Asia into two sections. One will encompass Japan, Korea, and the remainder of the East Asia and Australia region. The other will include south and southeast Asia, including Indonesia and the Philippines. In addition, the Eastern Europe segment will split off Russia and Ukraine from its operations in North Africa, Turkey, and the Middle East. Philip Morris hopes this will help highlight key areas like Japan as drivers for the rest of the company.
5. Philip Morris wants lower taxes
In some countries, the tax differential is very attractive on reduced-risk products or iQOS versus combustibles. I don't think in the long, long term that level of a tax differential will be maintained if it stays perfect, but I do think that this product will enjoy a lower taxation than the conventional cigarette.
Philip Morris knows it has to demonstrate advantages from its reduced-risk products compared to traditional cigarettes in order to satisfy regulators and consumer advocates. Yet implicit in that move is the idea that the tax levels on cigarettes are intended to compensate governments for the costs of traditional cigarettes, and therefore that lower taxes are appropriate if the risks are reduced. Regulators are only now considering those issues, but it will be critical for Philip Morris to gain favorable treatment. That way, it can boost after-tax profit even without corresponding revenue increases.
Philip Morris has seen its stock do extremely well, even though its business faces plenty of challenges. With the huge potential of iQOS, Philip Morris is working to make sure its future is as bright as its past has been.
