Now that Philip Morris International (PM +6.57%) has decided to forgo a merger with Altria (MO +0.56%) and instead focus on marketing its IQOS heated tobacco device in the U.S., its upcoming earnings report takes on much more importance.
Previously, earnings release could have been largely ignored, because the real driver for the future would have been the merger of Altria and Philip Morris into an international tobacco force again -- particularly with Altria's investment in electronic cigarette maker Juul Labs. But now, how Philip Morris itself is performing will again be of central interest.
With the earnings report expected on Oct. 17, let's see what investors can anticipate.
An IQOS heated-tobacco device. Image source: Philip Morris International.
Heated tobacco remains the key
The cigarette industry remains in a decline. Year-to-date shipment volume for Philip Morris is down 1.9% from the same time last year, and it was off 2.8% for all of 2018. Currency-adjusted revenue, however, is up 6% so far, reflecting price hikes as well as greater shipment volumes of IQOS, which are up 29.2% in 2019.
IQOS is where Philip Morris has staked much of its future, so this is good news for investors since it shows there is still ample room for growth as the heated-tobacco device is introduced into more markets.
Japan remains the biggest market for IQOS, only because it is the oldest. Having saturated the market after its initial introduction in 2016, Philip Morris has struggled to see sales grow meaningfully, and revenue in the East Asia and Australia region over the first six months of 2019 is down 6.6%.
That's because of a combination of falling cigarette sales, particularly in Australia, and lower cigarette and IQOS shipment volume in Japan and -- to a lesser extent -- Korea. Even so, the region's shipment volume of 15.2 billion units is greater than all other regions combined.
Rising markets outside Japan
The European Union and Eastern Europe are the next two largest regions for heated tobacco, respectively, with volumes growing by triple digits, particularly in Russia and Ukraine.
Market intelligence site SimilarWeb, which measures traffic to tens of millions of websites, found that IQOS sites globally have seen a 30% increase in traffic year over year through August, and that Russia is the fastest growing and now accounts for almost 20% of the total (Japan still represents 30%, but it's in decline).
IQOS' future in the U.S., however, will be the key because this country is the world's largest e-cig market.
Altria just began marketing the IQOS under its Marlboro brand in the Atlanta area, and will use the results from the pilot program to roll it out to the rest of the country. Because it is the only e-cig on the market that has received Food and Drug Administration marketing approval (which Juul lacks), something all manufacturers will have to get next year, it has a considerable lead on the competition. Moreover, as questions about Juul e-cigs mount, there could be a tremendous land-grab opportunity here.
The risk Philip Morris faces is that IQOS gets lumped in with all the other e-cigs in the minds of consumers. As concerns over health-related vaping risks grow, analysts at Cowen & Co. found that traditional cigarette use bounced 1 percentage point higher in September following numerous consecutive months of decline. It's still lower than it was during the summer, but concerns about vaping's role in lung illnesses and deaths intensified last month.
Smoking still rules
Philip Morris is likely to report that revenue once again grew in the third quarter and that consolidated volumes fell from declining cigarette sales. Greater uptake of the IQOS device in established and emerging markets will more than offset the decline of cigarette shipments, and the U.S. market is only just getting started.
Yet cigarettes are still Philip Morris International's moneymakers, with cigarette shipments outpacing heated tobacco units by 13 to 1. Yet cigarettes remain in a secular decline, and reliance on price increases to bolster revenue and profits should hasten their fall. Cigarette alternatives ought to be the future, and their strength will become more evident this quarter.
