Global regulatory threats and a downward trend in the number of smokers worldwide are forcing major tobacco manufacturers including Philip Morris International (NYSE:PM) to identify alternative streams of revenue growth.
Governments worldwide are making it harder for tobacco companies to market and sell cigarettes. The regulatory measures include bans on cigarette advertisements, mandates for plain packaging, requirements for graphics on cigarette packets which indicate the effects of smoking, court monitoring of sales and marketing activities of tobacco companies, and excise duties on cigarettes. The excise duties have led to sharp increases in cigarette prices, forcing smokers to look for alternative means. Further, there are other regulations that have been a long-term distraction for the tobacco companies and have taken up substantial amounts of time and money.
In addition, there is a growing awareness globally regarding the health hazards due to cigarettes, and this has led to two trends. First, fewer people are becoming smokers. Second, existing smokers are either trying to quit the habit, or looking at alternative means of nicotine consumption. These alternatives include chewing tobacco, snuff and electronic cigarettes. This trend is very pronounced in developed countries such as the U.S., Canada and the European Union. It has not yet reached the developing countries in Asia and Latin America, but it is expected to have an effect in the long term.
Philip Morris International has started to explore these alternatives. In 2009, it entered into a joint venture with Swedish Match AB to commercialize Swedish style “snus” and other smoke-free tobacco products on a worldwide scale, starting with markets such as Canada and Russia. Although revenues from this stream still constitute a negligible portion of the company’s worldwide revenues, we expect it to increase substantially in the long term.
The company is in the process of developing a number of next generation products where tobacco is heated rather than burnt so as to release less smoke and tar. It plans to introduce these cigarettes under the existing brands such as Marlboro by 2017.  It has also purchased the rights to an aerosol nicotine delivery system developed by researchers at Duke University. 
Electronic cigarettes have emerged as a major long-term competitor to the cigarette industry. They offer a less harmful method of nicotine consumption, and the industry is currently unregulated. Although Philip Morris International has yet to enter the market for this product, some of its competitors are placing large bets on e-cigarettes to drive long-term revenue growth. For example, British American Tobacco has set up Nicoventures, which is in the process of developing a number of products based on electronic cigarette platforms. Philip Morris is currently not too keen on electronic cigarettes as evidenced by a recent presentation in Lausanne, where the COO dismissed these products as having a poor sensory experience and weak nicotine delivery profile.  We suspect that it may change its stance if the market for this product grows as projected.
We currently have a Trefis price estimate of $89 for Philip Morris International, which is about 4% below the market price.Notes:
- Philip Morris to Introduce Lower-Risk Cigarettes by 2017, Businessweek, June 2012 [↩]
- Philip Morris Looks To Nicotine Aerosol, WSJ, May 2011 [↩]
- Remarks by COO André Calantzopoulos, Investor Day, Lausanne, June 2012 [↩]