Philip Morris International (PM 0.50%) is proving that alternatives to traditional cigarettes are not only a viable option, but also a profitable one. The global tobacco giant's second-quarter earnings report indicates it may not be long before its IQOS heated tobacco electronic cigarette becomes its primary revenue producer.
IQOS expanding globally
Adjusted revenue of $7.7 billion rose 9% year over year in Q2, handily outpacing Wall Street's expectation of just $7.4 billion, while non-GAAP (adjusted) earnings of $1.46 per share beat last year's $1.41 and easily whipped analyst consensus estimates of $1.33.
An IQOS device. Image source: Philip Morris International.
Its combustible cigarette business is getting by on price increases, since shipment volumes fell 3.7%, worse than the 2.5% decline the industry as a whole experienced. But Philip Morris' heated tobacco division saw a 37% increase in volume, shipping 15.1 billion units, with revenue hitting $1.5 billion. The IQOS now represents 14% of the company's total reduced-risk product (RRP) revenue, which in turn accounts for about 20% of the company's total net revenue.
In markets where its heated tobacco device has been commercialized, it has a combined market share of 5%, even though in many of those countries it has not fully infiltrated all regions. There were over 11 million users globally at the end of the second quarter, an estimated 70% of whom, or 8 million users, have completely switched to IQOS from cigarettes.
Heated tobacco is an earnings driver
Spurred on by strong growth across the European Union, Japan, and Korea, while also increasing market share in Europe and Russia, the company announced it will invest an additional $100 million in the IQOS device, bringing the total it intends to spend on RRPs to $400 million. Most of the additional expenditures will be in the third quarter.
It also boosted its full-year earnings guidance, saying it now expects its adjusted EPS to grow by 9% or more in 2019 to $4.94 per share, a percentage point higher than the $4.87 increase it previously forecast. On an adjusted basis, the company indicates it expects earnings of at least $5.28 per share from the $4.84 per share profit it recorded in 2018.
This also happens to be before the contribution the U.S. market will deliver to Philip Morris, which in April received approval from the Food and Drug Administration to begin selling the IQOS. Through a marketing agreement with Altria (MO 0.12%), the electronic cigarette will be sold under the Marlboro brand. It will first be tested in Atlanta before it's rolled out to more markets and then nationally.
One of the biggest opportunities is still to come
It comes at an important time for e-cigs in the U.S. as the FDA is cracking down on their proliferation due to teen use of the devices, which has been labeled an "epidemic." Manufacturers may have less than a year's time to submit applications to the FDA to have their devices approved for sale.
The agency then has a year to decide whether to permit them to stay on the market, a notable timetable because it took the FDA over two years to decide whether the IQOS could be sold. An application by Philip Morris to market the IQOS as a reduced-risk product -- meaning users are likely to experience less harmful side effects than if they continued smoking traditional cigarettes -- is still pending a decision.
If the FDA continues moving at its typical glacial pace, Philip Morris and the IQOS could be one of a very few cigarette alternatives left on the market, assuming manufacturers can even make the submission deadline.
The global growth the company is experiencing with IQOS, plus the potential for acquiring large swaths of share in the U.S., give it a lot of runway for further growth.
