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Philip Morris Focuses on RRPs Amid Low Cigarette Volumes

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Philip Morris International Inc. PM is progressing well with its business transformation in the face of consumers’ rising health consciousness and stern regulations to dissuade smoking. To this end, the tobacco giant has been expanding in the reduced risk product (RRP) category, which is gaining traction. Also, the company’s solid pricing strategy has been providing cushion to its combustible category, which is bearing the brunt of receding cigarette volumes.

Cigarette Volume Softness Lingers in Q4

Philip Morris continued to witness lower cigarette volumes in fourth-quarter 2019, wherein total cigarette and heated tobacco unit shipment volumes dropped 5% to 192.2 billion units. Cigarette shipment volumes slid 8% to 175.1 billion units. Furthermore, revenues from combustible products fell 3% to $6,179 million in the quarter due to declines in all regions, except for South and Southeast Asia.

Total industry volume for cigarettes and heated tobacco units fell 2% in 2019, wherein Cigarette shipment volumes declined 1.4%. In 2020, total cigarette and heated tobacco unit shipment volumes are likely to drop 2.5-3.5% on a like-for-like basis. In fact, international industry volumes are also expected to decline due to higher excise taxes in Indonesia and the cigarillo category gaining traction in Japan. 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 raised concerns regarding the consumption of e-cigarettes among the youth.

Focus on RRPs & Pricing Aids

Rising health consciousness has pushed consumers toward low-risk RRPs. With radical investments toward research and development in the RRP 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. It expects such advanced and high-quality products to help adult smokers switch from traditional cigarettes to smoke-free options.

We note that RRPs formed close to 19% of the company’s total revenues in 2019, including about 13% contribution from IQOS devices.   Also, strong growth in IQOS boosted revenues in the RRP unit, which increased 36.2% to $1,534 million in the fourth quarter. Moreover, heated tobacco shipment volume of 17.1 billion units rose 40.7% year over year. Notably, IQOS is now available in nearly 52 markets worldwide, which forms 44% of the total international market.

The company expects consistent growth in IQOS and Heated Tobacco categories, and therefore, remains committed to expanding these product lines. Among other initiatives, Philip Morris announced a partnership with South Korea’s KT&G this January in order to commercialize the latter’s smoke-free products outside the country. The global collaboration aims at expanding the reach of KT&G’s smoke-free products to many other markets.

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 variance was an upside to the company’s performance across several regions during the fourth quarter of 2019. The company expects pricing to be strong in 2020 despite some anticipated hurdles in Indonesia.

Notably, the Zacks Rank #3 (Hold) stock has gained 18.5% in the past six months, outpacing the industry’s growth of 12.8%.

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