Philip Morris Bets Big On Its “Reduced-Risk” Products

Philip Morris International (NYSE:PM) recently announced that it would be spending almost $700 million over the next couple of years on constructing a new manufacturing facility and an associated pilot plant in Italy. These facilities would produce “reduced-risk” tobacco products that the company plans to start commercializing during the second half of this year. ^[1]

After a tough 2013, Philip Morris International continues to face headwinds from anti-tobacco measures and weak macroeconomic conditions in some of the key markets. (See: Philip Morris International In 2013: A Tough Year In Review) As a result, the company has accelerated the commercialization process for its newly developed products that are intended to reduce health risks associated with smoking traditional cigarettes. These new cigarettes rely on heating instead of burning tobacco, which produces most of the toxins that cause cancer and other tobacco-related diseases.

The company that sells Marlboro internationally, plans to start rolling out these reduced-risk products in some of the test markets by the end of this year. The pilot plant for these new products is almost complete. However, the larger manufacturing facility would take almost two years to complete. Together, these two facilities would have a capacity to manufacture around 30 billion units of next generation cigarettes annually. ^[1]

Philip Morris International believes that these reduced-risk products imitate the conventional cigarettes better than e-cigarettes, and are therefore, likely to be more appealing to smokers. The company expects the market for these products to grow to around 30-50 billion units, which is around 3-5% of the total conventional cigarettes market, over the next few years. This is the reason it is investing so heavily in these products.

The total planned expenditure of ~$700 million for the construction of these two new manufacturing facilities is around 70% of its annual capital expenditure for 2012. ^[2] We have therefore, revised our forecast for the company’s capital expenditures upwards for the next couple of years.

However, we do not expect to see a huge positive impact on its net revenues from this investment in the short to medium term. This is because the market for these products is in its very nascent stage. Even if it grows to say 40 billion units over the next 3-4 years, and Philip Morris commands a 30% share of it, that would still imply just 12 billion additional units for the company, which is slightly more than 1% change over its current annual sales volume. Apart from this, we also believe that these new product launches would put the company’s operating margins under pressure as well over the next couple of years.

However, our $93 price estimate for Philip Morris International is still over 10% above its current market price.

See Our Complete Analysis For Philip Morris International

Apart from investing in the development of these new cigarette alternatives, Philip Morris International is also eyeing the fast-growing e-cigarettes market. The company recently entered into an agreement with Altria (NYSE:MO), which gives it the right to market its MarkTen e-cigarettes internationally. (See: Altria, Philip Morris International Join Forces In Commercializing Cigarette Alternatives)

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

1. Philip Morris International to Invest up to €500 Million in Reduced-Risk Product Manufacturing Facility in Italy, pmi.com [↩] [↩]
2. Philip Morris International SEC Filings, sec.gov [↩]