Weekly Tobacco Notes: Philip Morris’ Asia Situation, Reduced-Risk Products Strategy

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In our tobacco industry notes for this week, we focus on Philip Morris‘ (NYSE:PM) presentation at the the Morgan Stanley Global Consumer & Retail Conference. The CEO of the company spoke on the challenges facing Philip Morris in the Asia-Pacific region, especially the Philippines and Indonesia. We also take a look at the information provided by the company on the latest commercialization of their reduced risk heat-not-burn product in Japan and Italy.

Our price estimate for Philip Morris’ stock is $79 per share, which is about 10% below the market price. The stock dropped slightly over the week. We have a revenue (net of excise tax) estimate for Philip Morris in 2014 of $30 billion, in line with the analysts consensus estimate compiled by Bloomberg Businessweek. [1]

See Our Complete Analysis For Philip Morris International

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Philip Morris’ State Of Affairs In Indonesia

We have written previously on how Indonesia is one of the most promising markets for Philip Morris in Asia (see Philip Morris Likely To Further Gains In Asia). An estimated 70% of the men in Indonesia in the age group 20 and above are smokers. This has led to strong growth in revenues in recent years.

The robust growth of the industry was expected to halt temporarily in 2014 following a decline in disposable income and an excise tax increase. Disposable income decreased due to the anemic growth of the economy, with the Indonesian economy’s third quarter growth being the lowest in five years. [2] The government also increased the excise tax on cigarettes by an average of nearly 9%. [3] The price increase by Philip Morris in response to this excise tax hike caused the price of cigarettes to cross a psychologically important level of 1000 rupiah (roughly 8 cents) per stick. This proved to be beneficial to the company. Competitors who had been undercutting prices raised them to match Philip Morris, thereby reducing the decline in the sale of its cigarettes due to the higher prices. This has led to a steady increase in the company’s market share since the first quarter of this year. [4]

The Philippines

Philip Morris has complained for a long time about the malpractice with respect to excise tax avoidance perpetrated by its key competitor in the Philippines. The excise tax in the country was alleged to be favoring the excise tax avoidance by its rival, Mighty Corporation. Taxation of tobacco products was based on two tax slabs, with a flat rate that did not vary within a tax slab. Cigarettes priced under 11.50 Philippine pesos (PHP) per pack were taxed at 2.72 PHP per pack. However, cigarettes priced above 11.5 PHP per pack were taxed at 12 PHP per pack. This huge rift between the two rates of taxation provided an opportunity for Mighty Corporation to mask its excise tax exposure and pay the lower taxes corresponding to the lower rate. [5]

However, the government has now decided to rationalize the tax code and create a single specific tax tier system by 2017. In the interim, tax hikes geared towards the lower tax segments are being implemented to close the gap between the two segments. This should improve Philip Morris’ position in Indonesia as its key competitor’s tax burden increases, making it unsustainable for them to maintain their low prices. [5]

Launch Of IQOS In Japan and Italy

Philip Morris launched its heat-not-burn e-cigarette iQOS in two cities, Nagoya in Japan and Milan in Italy. IQOS does not burn tobacco to release nicotine, but heats a capsule filled with nicotine solution to release nicotine-containing vapors. We have written earlier on how Philip Morris entered this segment in early 2014 (See Philip Morris Finds Its Footing In The Electronic Cigarette Industry). The company is holding off on any claims of health benefits vis-a-vis tobacco based cigarettes, pending results from detailed scientific tests. [5]

IQOS is being sold through 1000 retail outlets including one flagship store in Nagoya, which is Japan’s fourth largest city. They have been priced to maintain parity with regular Marlboro cigarettes. Initial consumer reaction has been reported by the company to have exceeded expectations. There are favorable headwinds on the regulatory side as well, with the Japanese Government deciding to tax these products at a lower rate than tobacco-based cigarettes. Price parity with traditional cigarettes is being maintained during the launch of IQOS in Milan. Although these are slated to be taxed at the same rate as traditional cigarettes, the company has expressed hope that the Italian Government will reconsider this decision going ahead. After national roll-outs of these products in Japan and Italy in 2015, they will be launched in other markets in 2016. [5]

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Notes:
  1. Philip Morris Earnings Page At Businessweek []
  2. Indonesian Economy’s third Quarter Growth Lowest In Five Years []
  3. Government Raises Cigarette Excise []
  4. Philip Morris At the Morgan Stanley Global Consumer & Retail Conference []
  5. Philip Morris Has A Problem In The Philippines [] [] [] []