Philip Morris’ 2014 In Review Part 2: Regulatory Challenges

In a recent note, we discussed Philip Morris International‘s (NYSE: PM) 2014 performance, specifically related to the reduced-risk product category. In this note, we take a look at the company’s dealings with various national and international regulators in 2014.

We have a price estimate for Philip Morris’ stock price of around $80 compared to a market price of around $83.

See Our Complete Analysis For Philip Morris International

Stringent Regulation In Australia Drives Philip Morris Away

Australia has enforced tax hikes and plain packaging laws on the cigarette industry, in response to health-related concerns (see Impact Of Strong Regulations In Australia). These regulations led led to a large decline in the domestic demand for cigarettes, which in turn led Philip Morris to shift the production of cigarettes intended for Australia to South Korea, since the low demand did not warrant a manufacturing facility in the country (See Our Weekly Tobacco Note).

These restrictions have had severe consequences for Philip Morris. Economists at the Commonwealth Bank of Australia say that the consumption of cigarettes and tobacco in Australia dropped 7.6% in the first quarter of this calendar year. Philip Morris’ market share in the first quarter fell to 32.9%, from the previous two year average of 37.7%. This was because consumers shifted to more affordable brands of cigarettes, such as those of Philip Morris’ rival British American Tobacco.

Ireland Looking To Enact Plain Packaging Law

Following Australia’s lead, Ireland is also mulling a plain packaging law. Ireland also has strong public health motivations to pursue such a law. It is estimated that on average, people in Ireland start smoking at the age of 16.4 years. This is younger than the equivalent age for any other country in Europe. Seventy-eight percent of smokers start smoking before the age of 18 (see Ireland’s Tobacco Legislation).

Ireland’s effort at legislating a plain packaging law is considered a bellwether regulation for the rest of the European Union. The number of cigarettes sold in the E.U. is expected to decline from 450 billion currently to 375 billion in 2021. If the adoption of smoking among the younger segments of the population is thwarted by more effective regulations, it could mean the market could shrink further. Faced with such grim prospects, tobacco companies are considering suing the Irish Government over this law.

Uruguay Sued By Philip Morris Over Plain Packaging

In another clash with regulators in 2014, Philip Morris sued Uruguay for $25 million for increasing the size of the graphic health hazard warnings on its cigarette packets.The company says that this violated its trademarks. There is also a sense of urgency with respect to the Uruguayan cigarette market for Philip Morris. Between 2005 and 2011, smoking has declined at the rate of 4.3% annually. By 2012, this reduction meant that less than 20% of the population smoked. This law is also considered a bellwether regulation, and it has received support from various quarters. For instance, the World Health Organization (WHO) criticized Philip Morris for engaging in devious practices to get the law dismissed (See Our Weekly Tobacco Note).

Spillover Effects Of China’s Law Threatens Asia Business

The Chinese Government is also considering restrictions on tobacco advertisements and public smoking. China has nearly a third of the world’s smokers, who smoke 40% of the world’s cigarettes. In 2013, China’s tobacco industry generated roughly $156 billion in profit before tax. However, 98% of this market is currently in the hands of the government-owned China National Tobacco Company (CNTC). Philip Morris has a licensing agreement with it, which lets CNTC market Marlboro cigarettes in China. This has given Philip Morris a measly 0.3% market share in the country. However, the law could affect it in other ways. CNTC has historically exported a very small percentage of its production. In 2010, this figure was only 1%. The new law could reduce the domestic demand in China, prompting CNTC to export more. This could erode Philip Morris’ revenues and/or margins in Asia should CNTC be prompted to compete with it in the lucrative cigarette markets of Asia outside China. This is especially important because the Asia division is the largest contributor to our valuation of Philip Morris, at around 36% of the company’s value (See Our Weekly Tobacco Note).

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