Few companies have the worldwide scope of tobacco giant Philip Morris International (NYSE:PM), which is a major provider of cigarettes and other tobacco products in dozens of countries. Yet one of the biggest elements of Philip Morris' leadership recently has been its dedication to the idea of replacing traditional cigarettes with reduced-risk products (RRPs). That's a tough sell for many investors, but signs of success on the business front have some starting to hold out hope for the idea as a viable long-term strategy.
Following Philip Morris' most recent earnings release, CFO Martin King talked with investors about various initiatives that the tobacco giant is pursuing. Despite inevitable bumps along the way, King and his fellow executives are optimistic about the eventual success of its move toward a reduced-risk future.
1. Despite disappointments, Philip Morris still believes in iQOS
With regard to iQOS, we are tracking below our very high initial expectations for this year, primarily due to the current growth trajectory in Japan. However, the-year-on-year performance across geographies remains very strong, and we continue to view RRPs as our largest growth opportunity going forward.
Many investors have focused on the apparent slowdown in growth of the iQOS heated tobacco system in Japan as a source of worry for Philip Morris. Although King acknowledged that market share for the HeatSticks inserts used for iQOS fell by 0.3 percentage points in Japan, a 15.5% reading is still well up from the 10% share that Philip Morris had there a year ago. Moreover, sales of 6.6 billion units during the quarter were up 5% from the first quarter of 2018, and the company is still seeing a lot of consumer interest in the category.
2. How Philip Morris is aiming to fight back in Japan
We remain focused on reaccelerating HeatSticks' share growth, particularly as competitors expand the availability of their heated tobacco products. In this regard, we're rolling out a range of initiatives this year, which do not require incremental marketing expenditures to drive further switching to iQOS.
With more than a third of adult smokers having used heated tobacco, Philip Morris understands that it has to pull out all the stops now in order to capture new users as they're making what could become lifelong decisions about loyalty to a heated tobacco brand. Philip Morris intends to introduce next-generation iQOS devices, new variants of HeatSticks that include a strong-tasting premium option, as well as a less-expensive value product. And it plans to make it easier to go through the registration process for new users. That might not pay off immediately, but Philip Morris sees substantial benefits coming as soon as 2019.
3. Philip Morris' outlook suggests a slower shift
We continue to anticipate a total industry volume decline of 2% to 3%, excluding China and the U.S. Against this backdrop, we also continue to expect a decline in our total shipment volume of approximately 2%. However, we now anticipate a change in the composition of our shipment volume, reflecting higher cigarette volume and lower heated-tobacco-unit volume compared to our prior forecast.
Philip Morris has pushed full speed ahead on its RRP initiatives, so it's surprising to see the company pulling back on its previous guidance on how quickly it could make the shift. The tobacco giant sees heated tobacco shipments of about 41 billion to 42 billion units, down 5 billion units from its previous forecast. The good news is that combustible products like traditional cigarettes have been doing better than expected. Yet most investors are disappointed by the lower-than-expected shipments of iQOS devices to key markets like Japan, and it'll be important to watch how the company's figures pan out for the rest of the year.
4. Philip Morris thinks iQOS can beat electronic cigarettes
We know that iQOS is a better product from the point of view of converting consumers, especially adult smokers. It has lower dual usage [of tobacco and e-cigarettes]. It has higher conversion rates than e-cigs. The taste is closer, and the delivery of nicotine and the satisfaction of smokers is much closer to cigarettes.
As Philip Morris expands introduction of iQOS around the world, it faces many markets in which electronic cigarettes have already gained a major foothold. Despite concerns among some investors that iQOS will have trouble competing in those markets, Philip Morris believes strongly that the experience of using its heated tobacco products far exceeds what e-cigarettes can deliver. In its own exploration of e-cigs, Philip Morris seems to view that market as more commoditized, giving it opportunities to come out with its own e-cigarette products but also making it important to coordinate to make sure that its overall RRP portfolio is optimal.
5. Russia could become a huge iQOS market
We're having terrific results in Russia. ... We will continue to expand in Russia.
Japan's iQOS market has captured most of the attention among investors, but Philip Morris has launched the product in key areas in Russia. With a 4.4% market share in the Moscow market, iQOS is off to a good start. King wasn't willing to commit to details about how quickly and where Philip Morris will expand its release of iQOS and HeatSticks in Russia, but it appears likely that the country will eventually play a key role in how successful the RRPs become worldwide.
It's committed to the strategy
Philip Morris gets a huge portion of its revenue and profit from traditional cigarettes, but lately, almost all of its commentary has surrounded the iQOS platform and other reduced-risk initiatives. That fact highlights just how committed Philip Morris is to a transition away from traditional tobacco, but it'll take a long time for that move to take full effect.