Philip Morris International (NYSE:PM) is in the unique position of trying to disrupt not only its industry but its own business as well. CEO Andre Calantzopoulos maintains that vapor, not smoke, will define its future even as some analysts begin to express skepticism that electronic cigarettes will have the long-lasting impact they once thought they would.
While Philip Morris heated tobacco device IQOS is still new to the U.S. -- which is the world's biggest e-cig market, meaning it may very well upend the order of things one day -- that's not going to be the case for when the global tobacco giant reports its fourth-quarter earnings results on Wednesday, Feb. 6.
A surprise in the making
Analysts are looking for Philip Morris to post a 2.4% rise in sales, but with a similar decline in earnings. However, there's good reason to suspect it could offer up a positive surprise.
The tobacco company reported that third-quarter shipment volumes fell, primarily because of sales volumes shortfalls in three markets, with two of those being timing related. Price increases were the main reason for the third.
It was those higher prices, however, that allowed Philip Morris to see profits rise, and management forecasts earnings per share to grow at least 8% annually through 2021. On a currency-neutral basis, it forecasts that its earnings for 2019 will be up 9%, and its performance will be widely bolstered by the growth of IQOS and the consumable heated tobacco units that are marketed as HEETS and HeatSticks.
Sales are "heeting" up
Across all of Philip Morris' markets, the IQOS has a combined 5.1% market share even though the heated tobacco device isn't even available yet in many places. It says that with that kind of broad market acceptance, it would be considered the fourth largest tobacco brand in these countries, a two-spot gain over the year-ago period.
The European Union represents the largest market where IQOS has been commercialized, accounting for 57% of the industry's volume, and HEETS share doubled year over year to 2.5% while in-market sales volume jumped more than 9% sequentially over the second quarter.
Russia is another market where IQOS is gaining adoption, with its market share hitting 4% and sales surging 40% sequentially to hit 2.4 billion units.
Japan, of course, represents Philip Morris' most advanced market, as IQOS was introduced there first, so its market share of 17% in the country, up 1.5 percentage points year over year, was not surprising, even though it initiated price bumps and faced tax increases, too.
Still grounded in tobacco
As much as Philip Morris touts its commitment to a smoke-free future, the tobacco giant still has a sizable traditional cigarette portfolio that continues to generate most of its sales and profits.
Like its peers Altria and British American Tobacco, Philip Morris commands significant pricing power that, while causing it to lose some customers over time, still finds the vast majority of them willing to pay up for its brands. Over all of its markets, it saw prices rise nearly 6% in the third quarter for its combustible tobacco products.
It's also able to use the inelasticity of demand for cigarettes to offset higher excise taxes that countries are fond of imposing, so that where other products would have to absorb some of the cost of higher taxes, tobacco companies are able to pass them along to customers.
A future of innovation
Still, the driving force for Philip Morris' future is in reduced-risk products like IQOS, and it has spent billions of dollars developing a portfolio of different options. Most recently, it partnered with South Korean e-cig firm KT&G to distribute the company's vaporizer equipment outside its home market.
KT&G sells products that vaporize traditional tobacco under the Lil brand, as well as e-liquids. Philip Morris won't extend that distribution to the U.S., though, as it prepares for the national rollout of IQOS under Altria's direction.
IQOS is currently just in two U.S. markets -- Atlanta and Richmond, Virginia -- but more will be coming soon. As the device is the only e-cig to which the Food and Drug Administration has granted marketing approval, there's a good chance it will have much of the U.S. market to itself when the agency's deadline for submitting applications expires in a few months.
Like the analysts, Philip Morris International does have concerns about the regulatory environment surrounding e-cigs, particularly in the U.S., which underscored its decision to kill any more talk of a possible merger with Altria. Both companies, says Calantzopoulos, are focused on commercializing IQOS instead.
Even so, the IQOS in the U.S. won't be a contributor to Philip Morris International's fourth quarter and full-year results in any appreciable scale. That's coming, but investors betting on a big score on that front should look to 2020 and beyond for its role to become magnified.