One of the biggest advantages Philip Morris International (PM +0.31%) has over U.S.-based rivals such as Lorillard is its dominance in international markets, where regulatory and public scrutiny of tobacco products is much lower than in the United States. Philip Morris International was spun off from Altria Group in 2008, to free it from the shackles of the domestic regulatory environment. This proved to be a wise decision, since Philip Morris shares are up 78% since its spinoff, compared to a 55% gain for the S&P 500. And this doesn't even include Philip Morris' high dividend yield, currently at 4.6%.
But more recently, Philip Morris' growth has hit a bump in the road. The company has struggled with slow progress in new product innovations, specifically e-cigarettes, which is the next true growth avenue for tobacco companies. Fortunately, Philip Morris has a plan. Here is a look at Philip Morris' entry into electronic cigarettes and what it could mean for growth at the company.
Introducing iQOS
Philip Morris is banking on its iQOS electronic cigarette, which heats rather than burns tobacco, to do well in that category, where competitors are already in the market. Philip Morris will produce Marlboro HeatSticks that are inserted into the iQOS device to give a tobacco flavor. Philip Morris does not make any health claim with this product. Instead, marketing will focus on the innovative qualities and the fact that the Marlboro HeatSticks produce no fire or ash, and do not have cigarettes' distinct odor. The product will be initially tested in Italy and Japan this quarter, and are due to expand next year.
Philip Morris believes it can reap similar margins on its e-cig products as it does on traditional cigarettes. In the 1,000 retail outlets in Japan where the product is being tested, a pack of 20 Marlboro HeatSticks will cost about the same as a pack of regular cigarettes. The iQOS kit sells for about $59.31, according to an article posted on seekingalpha.com.
An added bonus for Philip Morris International is that this product qualifies under a separate category in Japan that allows for lower excise tax than cigarettes. This will not be the case in Italy, where the Marlboro HeatSticks will face the same level of taxation as regular cigarettes. Rollout of teh product is expected to expand in 2016 and beyond. It has the promise to keep profitability strong, and expectations are high for Philip Morris' e-cig products.
Back in June, Philip Morris was saying that once it hit 30 billion units of sales, iQOS would boost profit by $700 million at margins akin to those of cigarettes
Long-term investments set to pay off
Philip Morris International has invested approximately $2 billion over more than a decade to build up what it calls its "reduced-risk" portfolio, which includes e-cig products. Unfortunately, the extended amount of time needed for these investments to materialize means Philip Morris is late to the party. Competitors such as Lorillard have leaped ahead in the fast-growing e-cig category -- Lorillard's blu e-cig holds a 30% market share in the U.S. And, after buying out U.K.-based SKYCIG last year, Lorillard will also be a fierce competitor in international markets.
That doesn't mean Philip Morris can't catch up and eventually win the battle. After all, it's the largest publicly traded tobacco company in the world, carrying a massive $136 billion market capitalization. That means it has the financial resources to do just about anything it wants, and it's not going to simply sit on its hands and watch its competitors steal a huge opportunity. E-cigarette sales are estimated to reach $1.5 billion this year. CEO Andre Calantzopoulos said back in June that Philip Morris expects to generate about $700 million in annual revenue from the iQOS product once it hits 30 billion units of sales. That would represent about 2% revenue growth for the company each year, which doesn't sound like much. However, Philip Morris' revenue is actually down 3% through the first nine months of the year, so reversing that trend would be a meaningful step in the right direction.
If management's forecasts prove accurate, investors should be very excited about what the future holds for the company.
