Philip Morris International Turns To E-Cigarettes On Declining Demand For Traditional Ones

Philip Morris International (NYSE:PM) recently guided for a slower earnings growth rate next year due to higher investments in the commercialization of e-cigarettes and other lower health risk products, as the company expects sales volume of traditional cigarettes to remain under pressure. ^[1] It has been a tough year for the company so far due to the anti-tobacco measures in the key markets of Philippines and Russia, and continued macroeconomic headwinds in Europe. However, we believe that Philip Morris’ decision to enter the e-cigarettes market is a positive development for the company’s stakeholders, as a successful launch in the burgeoning category could help the company patly offset volume declines in the traditional category.

Philip Morris International is a leading international tobacco company with its products sold in more than 180 countries worldwide. Until its spin-off in March 2008, it was an operating company of Altria Group (NYSE:MO). Excluding the U.S. and China, the company holds more than 28% of the total international cigarette market, which is led by its flagship brand Marlboro.

Our $97 price estimate for Philip Morris International is more than 10% above its current market price.

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Volume Crisis

Philip Morris’ total sales volume for the first nine months of the year has declined by more than 5% y-o-y. This has also impacted the company’s stock price, which has gained just over 3% so far this year, while the S&P 500 has rallied by around 20% over the same period. ^[2] Below, we take a closer look at some of the key markets that are weighing on the company’s performance.

• Philippines: According to our estimates, Asian operations contribute almost 40% to Philip Morris’ total value. Three markets – Indonesia, Philippines and Japan – make up almost 80% of the total cigarettes shipped by Philip Morris to Asia. In 2012, almost one-third of total shipments were made to Indonesia, the fastest growing market in the region. This was followed by Philippines, which contributed another 22% last year. As mentioned in a previous article, the Philippines government implemented a ‘sin tax’ law this January, which resulted in an abrupt increase in indirect taxes on cigarettes. Following the sharp tax hike, the company increased prices of its Marlboro and Fortune brands by around 60% and 70%, respectively. As a result, Philip Morris’ cigarette shipments to the market fell by more than 20% during the first nine months of the year. This has had a huge negative impact on the company’s total sales volume this year. Almost 30% of the total volume decline reported by Philip Morris during the third quarter was due to its performance in the Philippines. ^[2]

• European Union: Philip Morris’ EU operations have been under pressure over the past few years due to the growing presence of illegally traded cigarettes in the region amid weak macroeconomic conditions and a difficult regulatory environment for tobacco products. Illegal cigarette trading is a huge concern for the local governments as well as cigarette manufacturers in the EU. Its growing prevalence has been exaggerating the decline in tax-paid cigarette consumption in the region. The tax-paid cigarette market has declined by ~20% in volume over the past five years while overall cigarette consumption in the EU has declined by ~17%. This is because the volume of illegally traded cigarettes grew by 8% to 65 billion units over the same period. More importantly, the trend has worsened over the recent years due to excise tax hikes and high unemployment rates that are driving consumers towards cheaper cigarettes. As a result, cigarette manufacturers in the EU have been witnessing sharp declines in sales volume. Philip Morris’ shipment volume in the region dipped by ~7% y-o-y for the first nine months of the year despite being able to maintain its market leadership. (See: Philip Morris’ Potential Downside From EU’s Illegal Trade)

• Russia: The world’s second largest market for cigarettes, after China, further aggravated operating conditions for Philip Morris during the third quarter. Shipment volumes in the country declined more than 10% as a result of the implementation of excise tax hikes and other anti-tobacco measures. The Russian anti-tobacco bill that was signed into law on February 25, 2013, came into effect on June 1. The law primarily aims at lowering annual smoking-related casualties in Russia by half over the next decade by restricting the marketing and sale of cigarettes and smoking in public areas. The company expects sales volume in Russia to remain depressed during the next year as well. According to the World Health Organization (WHO), the public smoking ban is the most effective tool for reducing smoking prevalence after indirect taxes. (See: What’s The Impact of Russia’s Anti-Smoking Law On Philip Morris?)

A Bet On The Burgeoning Category

With sustained volume pressure in the traditional cigarettes category in mind, Philip Morris places a long-term bet on the burgeoning category, as it plans to enter the e-cigarettes market next year. We believe that this is a positive development for the company as the new category could potentially help offset volume declines in the long run. Although there is a very small market for e-cigarettes as of now – in terms of both volumes and sales – it has been growing at a very fast pace. The global e-cigarettes market is expected to be around $2.5 billion in sales this year, almost double the size it was just two years ago. ^[1] We expect the market for e-cigarettes to continue to grow strongly in the medium term on growing awareness, trial and expanding retail distribution. Additionally, harmful health effects and high excise taxes applicable on traditional cigarettes are also expected to drive consumers towards the niche category.

Understand How a Company’s Products Impact its Stock Price at Trefis

1. Philip Morris International Inc. Presents at the Morgan Stanley Global Consumer Conference, pmi.com [↩] [↩]
2. Philip Morris International SEC Filings, sec.gov [↩] [↩]