Can iQOS Shake Up The US Market?

by Trefis Team
Altria Group, Inc.
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Philip Morris International (NYSE:PM) submitted a Premarket Tobacco Product Application (PMTA) for heat-not-burn technology product, iQOS, with the US Food and Drug Administration (FDA) on March 31st, in order to seek authorization to commercialize the product in the US. This was consistent with the company’s goal of submitting the application in the first quarter of 2017. This follows the Modified Risk Tobacco Product (MRTP) application filed with the FDA in December 2016. Once iQOS gets a go ahead,¬†Altria (NYSE:MO) will get exclusive rights to sell these products in the US. Altria and Philip Morris have been working on reduced risk tobacco products for a while. In 2015, the companies entered into a strategic agreement under which PMI markets Altria’s MarkTen e-cigarettes internationally, while Altria distributes PMI’s heated tobacco products in the US. The companies have also decided to partner on regulatory matters in relation to the products. In this regard, the two companies are working together on the PMTA for iQOS.

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According to Reuters, Philip Morris is the first company to seek US approval to market a tobacco product as being less harmful than traditional cigarettes since the new laws were introduced. And hence, logically, if they are also the first company to receive approval from the FDA, they will hold significant marketing advantage over other reduced risk tobacco products. The company believes that since its products heats the tobacco, instead of burning it, it will be safer for consumers. The product is already available in several test markets. Philip Morris launched iQOS in Nagoya, Japan in November 2014. Since then, the product has been rolled out in two dozen locations, including Italy and Switzerland. Japan can be considered as a key region for the company, as it is the only country where the national roll-out of the device has occurred.

Tremendous Growth Seen By iQOS Internationally

iQOS has witnessed phenomenal growth in Japan since it was first launched, with its market share steadily climbing. During FY 2015, the iQOS launch was expanded in Japan to reach 60% of the adult smoking population, and the national roll-out was completed in the beginning of the second quarter of FY 2016. In the recently released first quarter results for Philip Morris, it was noted that the product carried on with its strong sequential growth, reflected in the weekly offtake shares for Marlboro HeatSticks. The brand closed out the quarter with a weekly offtake share of 9.6% nationally, 11.6% in Tokyo, and 14.9% in Sendai. The strong performance in Sendai in particular demonstrates the growing potential of the heat-not-burn technology products in Japan.

iQOS has now been launched in 24 markets globally, following the city launches in Colombia and Lithuania during the first quarter, and in Poland and Serbia earlier in the month. By the end of the year, the company is targeting the product to be present in 30 to 35 markets globally, subject to capacity. More importantly, PMI estimates that approximately 1.8 million adult consumers have already quit smoking cigarettes and switched to iQOS.

iQOS- Market Share

According to a Wells Fargo analysis of the future for the iQOS platform, the product has the potential for expanding the profit pool growth of combustible cigarettes and RRPs in the next decade by 400 basis points, to a 12.5% CAGR for Philip Morris. Further, it was also found that iQOS could displace up to 30% of the cigarette industry in developed markets by 2025, speeding up the premiumization of the market. This lends credence to the fact that iQOS could be a game-changer for Altria and Philip Morris in the years to come.

What Factors Can Lead To A High Growth In The US?

The smoking rate has been on the decline in the US since the mid 1960s, as a result of the tax hikes, ban on tobacco marketing and smoking in public places, and growing awareness among the consumers. The smoking rate has come down from 20.9% in 2005, to 15.1% in 2015, and is estimated to decline at a rate of 3% per annum till 2040. The US, from where Altria generates all of its revenue, has had one of the steepest declines in the prevalence of smoking. Moreover, a number of states in the US are considering raising the cigarette taxes in the coming months. This will put increasing pressure on companies, such as Altria, to raise the prices of their tobacco products. Such initiatives will further pound the cigarette volumes of tobacco companies. In the face of such issues, having a reduced risk product in the portfolio will help to guarantee long term success.

Smoking Rate

Currently, the cigarette alternatives available in the market have centered on liquid-based products that produce a vapor, and contain no tobacco. These products have not been approved by the FDA yet, and the lack of tobacco may not give the same experience as cigarettes that many consumers look for. In this regard, since iQOS uses tobacco, it may appeal to such users, and given the fact that Philip Morris may be the first among the industry’s big players to get FDA approval, it would result in significant benefit to both PMI and Altria.

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