Philip Morris: Focusing On A Smoke-Free Future

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Philip Morris International
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Philip Morris International (NYSE:PM) seems to be fully committed towards designing a smoke-free future, wherein smokers’ demands are to be met through potentially less harmful alternatives to cigarettes. The company’s momentum continues to grow behind a full-scale effort to market smoke-free products that can ultimately replace cigarettes, after a successful iQOS launch, which has converted over two million adult smokers to it. According to Tony Snyder, Vice President of Communications, adult smokers are looking for products “that offer the satisfying taste, ritual, and pleasure they get from cigarettes, but with far lower amounts of the harmful compounds found in smoke.” PM has hired over 400 scientists and experts, along with an investment of more than $3 billion in research, product development, and scientific substantiation.

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Developing Cigarette Alternatives

When a cigarette combusts, it burns tobacco leaves to generate smoke, which contains nicotine, naturally found in tobacco, as well as many harmful chemicals. According to PM, it is these harmful chemicals, and not the nicotine, in cigarette smoke which is the primary cause of smoking-related diseases. It is for this reason that the company is developing alternatives to cigarettes, products without the smoke, but with nicotine and taste that can satisfy the existing smokers. In this regard, the company has a two-pronged product focus: one is to heat tobacco to generate a nicotine-containing vapor, while reducing the level of harmful chemicals, and the other way is to produce a nicotine-containing vapor, without using tobacco.

Laboratory tests on the aerosol of the company’s most advanced smoke-free alternative, iQOS, have shown significantly lower levels of harmful and potentially harmful constituents (HPHCs), and reduced toxicity than cigarette smoke. Furthermore, one 90-day study in the US, and one 90-day study in Japan, reported that smokers who switched completely reduced their exposure to selected HPHCs, approaching those observed in people who quit smoking for the duration of the studies. IQOS is currently present in key cities or nationwide in 25 markets globally, including Japan, Canada, Germany, Italy, and the UK, with plans to make it available in key cities in 30 to 35 countries by the end of 2017. The company has also filed a Modified Risk Tobacco Product Application (MRTPA) for the product with the US FDA.

iQOS- Reduced Toxicity

Need For Alternatives

According to WHO estimates, there will be over a billion smokers by 2025. With such a huge demand for tobacco products in the future, the presence of less harmful alternatives to cigarettes is essential. For this, not only do alternatives need to be developed, but they also must be appealing to consumers. A significant health benefit can only be achieved when a large number of smokers switch from cigarettes to such products. The company’s innovation pipeline includes four product platforms that can meet the varying preferences of adult smokers, aiding them in the switch.

Philip Morris also aims to transition its resources from cigarettes to smoke-free alternatives in the future, and has proposed regulatory policies that encourage the replacement of cigarettes with such alternatives. The company has recognized the serious health risks posed by cigarettes and other tobacco products. Hence, accordingly, they feel an obligation to develop and market products responsibly. Success in the cigarette business has given them the resources to pursue this ambitious vision.

Given the demand for these products, the iQOS platform has the potential for expanding the profit pool growth of combustible cigarettes and Reduced Risk Products (RRPs) in the next decade by 400 basis points, to a 12.5% CAGR for Philip Morris, according to a Wells Fargo analysis. 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 Philip Morris in the years to come.

Increasing Production To Meet Demand

In a number of markets where iQOS has been launched, its growth has been curtailed as a result of production constraints. The company started the year with 15 billion units of installed annual HeatSticks capacity, and expects over 32 billion units in total capacity to be available for commercialization this year. The company anticipates an installed annual capacity of approximately 50 billion units by year end. Philip Morris is also implementing its plans to reach an installed annual capacity of 100 billion units by the end of 2018, which would translate to 75 billion units in total capacity available for commercialization.

In support of these decisions, the company is increasing its planned capital expenditure in 2017 to $1.6 billion, up from the $1.5 billion estimated earlier. In March, Philip Morris announced its decision to convert its cigarette factory in Greece to a heated tobacco unit production facility. This would entail an investment to the tune of €300 million, and would involve the manufacturing of tobacco sticks used in iQOS, called Heets or HeatSticks. As the equipment needed for the manufacture of Heets is larger than that required for traditional cigarettes, the current plant area will be expanded. Once fully operational, the facility will have an annual capacity of approximately 20 billion tobacco sticks.

In June, the company also announced the building of a new manufacturing facility in Dresden, Germany, to produce Heets, which would require an investment of €320 million. Construction of this facility is set to begin in late 2017, and will be fully operational in early 2019. Besides this, the company is also investing €500 million in order to increase the production capacity in its Bologna facility, in Italy. This expansion is expected to be completed by late 2018.

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Notes:

1) The purpose of these analyses is to help readers focus on a few important things. We hope such communication sparks thinking, and encourages readers to comment and ask questions on the comment section, or email content@trefis.com

2) Figures mentioned are approximate values to help our readers remember the key concepts more

intuitively. For precise figures, please refer to our complete analysis for Philip Morris International.
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