Philip Morris International Inc. (PM - Free Report) continues to be whipped by regulatory hurdles surrounding the tobacco industry, which along with rising health consciousness have been denting Phillip Morris’ cigarette volumes. This has caused a 19.3% decline in the company’s shares in the past three months, wider than the industry’s decline of 13%. Nevertheless, the company’s reduced risk products (RRPs) category has been gaining traction, which should help it cushion the stock.
What’s Plaguing Phillip Morris Stock?
The tobacco space faces challenges as governments around the world are imposing restrictions on tobacco companies, which, in turn, are lowering cigarette consumption. Incidentally, 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 - Free Report) and other cigarette makers have been directed to put up self-critical advertisements on television and newspapers to dissuade customers from smoking.
Apart from this, the court wants tobacco companies to admit that cigarettes have been made addictive through the issuance of corrective ads. To add to the woes, the FDA is bent on drastically reducing nicotine in cigarettes to minimally addictive levels. Apart from these, 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 FDA to include e-cigarettes, pipe tobacco, cigars and hookah, in May 2016. Also, the European Union and the FDA have proposed a ban on menthol in accordance with the Tobacco Control Act.
These hurdles, which remain threats to companies like Altria, Vector Group (VGR - Free Report) and British American Tobacco (BTI - Free Report) , caused total cigarette shipment volumes to decline by 5.3% in the first quarter of 2018.
Any Scope for Respite?
To counter these hurdles, Phillip Morris is pioneering the radical shift from harmful tobacco products to scientific and low-risk alternatives, with investments in research and development in the RRPs category. In fact, the company’s iQOS, a smokeless cigarette, is counted as one of the leading RRPs in the industry. During first-quarter 2018, revenues from RRPs doubled (on a constant-currency basis) to $1,127 million, largely driven by increased sales of iQOS devices. Notably, RRP revenues during the first quarter represented 16.3% of the company’s overall net revenues.
Further, to cater to the rising demand for products in the RRPs category, Phillip Morris has been undertaking plant conversions, transforming them from cigarette to RRPs manufacturing facilities. This was witnessed in the company’s Papastratos factory in Greece, for the production of HEETS, a unit used with iQOS. Moreover, the marketing and technology sharing agreement between Philip Morris and its peer Altria Group, which is currently under FDA review, is also expected to boost the business of both the companies.
Apart from this, strong pricing should also help Phillip Morris fight the hurdles related to soft volumes. The company makes solid attempts to remain afloat and generate revenues with higher cigarette pricing even in the face of unfavorable tax environment and declining cigarette volumes. Though higher pricing might lead to possible decline in cigarette consumption, it is seen that smokers tend to absorb price increases, owing to the addictive nature of cigarettes. Evidently, higher pricing at the combustible tobacco portfolio drove year-over-year net revenue growth during first-quarter 2018. The company continues to expect pricing as the key growth driver in the near term.
That said, let’s see if strong pricing and gains from RRPs can actually help the Zacks Rank #3 (Hold) stock witness a turnaround. You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.
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