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Can Philip Morris International Inc. Reignite E-Cig Growth With the New iQOS?

By Rich Duprey - Apr 11, 2016 at 10:47AM

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Electronic cigarette growth has stalled, but this innovation could spark a new fire.

Tobacco giant Philip Morris may have developed an e-cig that offers the best of both worlds: real tobacco flavor with reduced-risk vapor. Image credit: Philip Morris International

Philip Morris International ( PM 2.25% ) probably won't appease the anti-smoking crowd that seems just as interested in stamping out tobacco companies as they are about curtailing the use of cigarettes, but the company's rollout of its new iQOS real tobacco electronic cigarette could revive the flagging sector.

Sales of electronic cigarettes sparked a dramatic change in the industry when they first went mainstream, and Lorillard was one of the first tobacco giants to recognize its potential, snatching up blu eCig and quickly turning it into the leading brand with nearly half the industry's market share. But other major tobacco companies soon entered as well, including Reynolds American ( RAI ) with its Vuse brand, Altria ( MO 1.16% ) with MarkTen, and a number of smaller independent names.

The competition loosened blu's hold on the market, and by the time Reynolds acquired Lorillard and sold blu off to Imperial Brands, its market share had fallen below 30%. According to Wells Fargo, blu eCig had just a 20% share at the end of 2015, while Reynolds' Vuse catapulted to the front of the pack with a near 39% share.

Overall, though, the fire for electronic cigarettes has gone out as vaping superceded e-cigs, and some users expressed dissatisfaction with the e-cig experience. It didn't help that a number of states enacted laws putting them on equal footing with regular cigarettes, and some smokers who had switched to e-cigs switched back to combustibles. Where it was once thought the industry could achieve some $10 billion in sales annually by 2018, such lofty targets are no longer mentioned.

Sales have decelerated significantly, with their five-year compounded annual growth rate of 114% being slashed to just 57% last year, according to Euromonitor International -- which is why Philip Morris' iQOS is such a big deal. Although the tobacco industry invested heavily in electronic cigarettes only to see their promise go up in smoke, one of the drawbacks to their proliferation was that it obviated much of the need for their primary product, traditional tobacco. Instead of burning tobacco leaves, e-cigs heated liquid nicotine. iQOS, on the other hand, gets the global tobacco giant back into its wheelhouse by using real tobacco leaves again, only this time not by burning them but heating them to produce a tobacco-flavored vapor.

That makes them different from the iFuse being produced by British American Tobacco ( BTI 1.28% ), which heats liquid nicotine and then draws it through tobacco for flavor.

U.K.-based British American Tobacco has a competing real-tobacco e-cig, though it only has limited availability and is part of its larger Vype family of electronic cigarettes. Image credit: British American Tobacco

Although they've been introduced in targeted cities in markets including Switzerland and Italy, later this month, Philip Morris will roll out iQOS nationally in Japan, making the country a sort of proving grounds for their efficacy.

Altria is also counting on their success. The iQOS will be marketed as Marlboro HeatSticks, capitalizing on a framework the two tobacco companies signed in 2013 for commercializing e-cigs and other reduced-risk products. They expanded the agreement last year to include a joint R&D and technology-sharing agreement. Both Reynolds and BAT have signed a similar agreement to develop their respective vapor products through 2022.

Since these hybrid e-cigs don't produce smoke or harmful tar and rely upon real tobacco to deliver flavor, they could address the biggest objections smokers have had to this new generation of offerings, taste, while feeding their own cash crop, tobacco.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis – even one of our own – helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.

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Stocks Mentioned

Philip Morris International Inc. Stock Quote
Philip Morris International Inc.
PM
$91.39 (2.25%) $2.01
Altria Group, Inc. Stock Quote
Altria Group, Inc.
MO
$44.43 (1.16%) $0.51
Reynolds American Inc. Stock Quote
Reynolds American Inc.
RAI
Wells Fargo & Company Stock Quote
Wells Fargo & Company
WFC
$48.81 (2.22%) $1.06
British American Tobacco p.l.c. Stock Quote
British American Tobacco p.l.c.
BTI
$34.86 (1.28%) $0.44
Imperial Brands PLC Stock Quote
Imperial Brands PLC
IMBB.Y
$21.07 (0.71%) $0.15

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

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