Philip Morris Battles Low Cigarette Volumes, Pricing Aids

Zacks Equity Research

In the wake of declining cigarette volumes due to stern regulations and consumers’ rising health consciousness, Philip Morris International Inc. PM has been focused on making its way through strong pricing and reduced risk products (RRPs).

Declining Cigarette Volumes a Concern

Declining cigarette sales volume has been taking a toll on Philip Morris’ performance. Although the metric was flat year over year in first-quarter 2019, the same declined almost 3.6% and 5.9% in the second and third quarters, respectively. We note that cigarette shipment volumes are being adversely impacted by lower demand for cigarettes, stemming from anti-tobacco campaigns and consumers’ rising health consciousness.

Moreover, the tobacco industry has been facing many challenges as governments around the world are imposing restrictions on tobacco companies, which in turn are lowering cigarette consumption. The U.S. Food and Drug Administration (FDA) has made it mandatory for tobacco companies to use precautionary labels on cigarette packets to dissuade customers from smoking.

In fact, per court orders, Reynolds American along with Altria Group MO and other cigarette makers has been directed to put up self-critical advertisements on television and newspapers to dissuade customers from smoking. To add to the woes, the FDA is now bent on drastically reducing nicotine in cigarettes to minimally addictive levels. Also, the FDA had raised concerns regarding the consumption of e-cigarettes among the youth. Apart from these, the FDA had earlier announced that tobacco makers must seek marketing authorization for any tobacco product introduced after Feb 15, 2007. The law was extended by the agency to include e-cigarettes, pipe tobacco, cigars and hookah.

Growth Efforts Underway

Rising health consciousness has pushed consumers toward low-risk RRP’s. With radical investments toward research and development in the RRPs category, Philip Morris is pioneering the shift from harmful tobacco products to scientific and low-risk alternatives. In fact, the company’s IQOS, a smokeless cigarette, is counted among one of the leading RRPs in the industry. The company expects such advanced and high-quality products to help adult smokers switch from traditional cigarettes to smoke-free options. In fact, strong growth in IQOS boosted revenues in the RRPs unit, which increased almost 63.4% to $1,344 million in the third quarter.

Going ahead, the company expects consistent growth in IQOS and Heated Tobacco categories, and therefore, remains committed to expanding these product lines. Philip Morris has also been undertaking plant conversions, transforming them from cigarette to RRPs manufacturing facilities. Among other initiatives, Philip Morris inked a deal with Canada-based Parallax that provides low-risk tobacco alternatives.

Apart from this, Philip Morris has been making efforts to remain afloat and generate revenues with higher cigarette pricing. Though higher pricing might lead to a decline in cigarette consumption, it is seen that smokers tend to absorb price increases owing to the addictive quality of cigarettes. Evidently, higher pricing at the combustible tobacco portfolio has been aiding the company’s performance for a while. In fact, higher pricing variance was an upside to the company’s performance across several regions during the third quarter of 2019. The company continues to expect pricing as the key growth driver in the near term.

All said, let’s see how far these initiatives can help Phillip Morris completely offset the aforementioned woes. Notably, the Zacks Rank #3 (Hold) stock has gained 4% in the past six months, underperforming the industry’s growth of 8.7%.

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