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  1. Home
  2. / Investing
  3. / Consumer Discretionary

Philip Morris Earnings May Have Disappointed, but Watch Those Heets!

The latest Philip Morris earnings were very disappointing, again. But in Asia, the company is transitioning away from cigarettes and toward next-gen nicotine products, as these figures show.
By ALEX FREW MCMILLAN
Oct 20, 2017 | 10:00 AM EDT
Stocks quotes in this article: TSLA, DMLRY, BMWYY, RYCEY, PM, MO

Investors saw the cigarette pack as half empty when Philip Morris International (PM) reported disappointing results. Shares slid 3.8% in New York trade as the company came in with earnings of $1.27 per share, well off the street's consensus estimate of $1.39.

In particular, cigarette sales slumped in Germany, where prices went up from €6 to €6.30 ($7.44) a packet, and Saudi Arabia, where a new tax doubled the price of a pack to 24 Saudi riyals ($6.40). Philip Morris lowered its full-year forecast for the second time in 2017, this time by $0.05 a share.

The poor figures caused Wells Fargo to say it was "disappointed" by the numbers. Jefferies said the company would face more foreign-currency headwinds than its global peers.

The maker of Marlboro shipped 198.5 billion cigarettes in the quarter, with those sales down 4.1%. People across the globe are stubbing out their cancer sticks, and frankly that's a good thing.

That's the short-term picture. But it's missing the point.

The strange thing is that Philip Morris agrees with you. They also want you to quit. They would like to get out of selling cigarettes altogether.

Actually, they want you to switch. The company, spun off from U.S. counterpart Altria (MO) in 2008, would like all smokers to transition to its "smoke-free" products.

It has four, the most famous and most successful so far being IQOS. That is an electronic charger and holder that is "heat-not-burn" technology. It has a cigar-size holder with a tiny ceramic plate that heats a small, filtered stick filled with tobacco (about half the length of a cigarette) to the point where the tobacco, crimped rather than loose-leaf like a cigarette, emits a vapor but does not combust.

IQOS has been a big hit in Japan, where it went on sale in late 2014, when the product also launched in Italy. IQOS is now on sale in South Korea.

I spent nine years in North Carolina, where I went to college in 1990 and got my first job at a state-wide business magazine, in 1994. The tobacco industry was already so dead in the water, that most of our coverage was about how Big Pharma and big farming were replacing Big Tobacco.

The IQOS system involves a charger and cigar-like holder that heats a tobacco stick half the size of a cigarette.
The IQOS system involves a charger and cigar-like holder that heats a tobacco stick half the size of a cigarette.

But smoking remains huge in Asia, where 60% of smokers now live. In Japan, one-third of adult men smoke. In South Korea, half of the dudes do. 

This was the first set of figures showing how sales of the PMI device IQOS are going down in South Korea. My own eyes told me that it's going down well. I've traveled to Seoul for work and will be heading to Japan to snowboard, eager to see how folks are switching from conventional cigarettes to "next-gen" nicotine products. The answer is that they are going down very well indeed.

Walk up to any given group of smokers huddled outside a Seoul office building, and every second or third group will contain a vaper or electronic smoker. Of course, while smoking, they talk to their friends. Maybe they let them have a try.

On a quick trip into a convenience store, I sat and watched as seven customers came and went. Two of them bought Heets, the tobacco sticks that go into the IQOS device.

So investors in tobacco stocks should look at the line item for "heated tobacco unit" sales for the future of the companies. Shipments of those tobacco sticks rose to 9.7 billion this quarter for PMI, up from 2.1 billion the same time in 2016 -- an increase of 362%.

The 9.7 billion tally is clearly a far cry from almost 200 billion cigarettes sold. So far this year, through nine months, the company has shipped 565.6 billion cigarettes, down 7.6%. It has shipped 20.5 billion Heet-style "heated tobacco units," up from 3.7 billion in 2016. 

It refers to Heets as Marlboro HeatSticks in Japan, but nobody really uses that moniker much, other than the marketeers. The Marlboro marque has been downplayed in Korea, where there's only a small "Recommended by Marlboro" on the back of the pack.

I've tried IQOS, unlike you, at least legally, if you are reading this in the United States. I'm a vaper, using a device from Juul Labs (a.k.a. the privately held Pax Labs, previously Ploom Labs) that heats a liquid containing nicotine salts until it steams into vapor, which I inhale.

Compared to that, IQOS is a lot like smoking a cigarette. Suspiciously so. PMI says the smoke/not smoke emitted contains 90% or less harmful substances than a cigarette, and has all the scientific propaganda to prove it. Since I'm not a scientist, I can hardly contest the data -- but my vaping device seems safer to me. 

But IQOS is supposed to be a lot like smoking a cigarette. That's the whole point. PMI says it is not looking to attract any new customers at all, and simply wants to switch existing smokers to a less-harmful substitute system (which, naturally, they supply with parts and tobacco content).

And I'm all for that. I have absolutely no doubt that IQOS is less bad for you than smoking a cigarette, significantly so.

Heets, introduced in May 2017, now make up 2.5% of the tobacco market in South Korea, including all brands. Marlboro's share fell from 9.7% to 8.5%. In Japan, HeatSticks now account for 11.5% of the total tobacco market, up from 3.5% the same time last year. Marlboro's share fell from 10.7% to 9.5%.

That transition and trend is clear. For a totally new product to have cornered more than 10% of the total market in Japan in less than three years ain't too shabby.

This success may be hard to duplicate elsewhere in Asia. Hong Kong and Singapore have unusually low levels of smoking compared with the rest of Asia. But they're the markets that would be next in terms of disposable income for makers of expensive nicotine devices to target.

But for now, there's no way in hell those governments will let you use anything other than a cancer-causing cigarette. Why, I don't know, unless Big Tobacco is lobbying hard behind the scenes to maintain the status quo.

That's entirely possible. Hong Kong had, since their introduction, waived the first-registration tax for electric cars, which normally doubles the price on a new vehicle. It didn't matter much because no one was buying electric cars in this image-conscious city, where there are more Rolls-Royces (RYCEY) per capita than anywhere on the planet.

Then Tesla (TSLA) came along. Its sedans were just as show-off as a Mercedes-Benz (DMLRY) or BMW (BMWYY) . Suddenly they were everywhere in Hong Kong, which is perfectly made for electric cars, with short distances to drive, lots of shopping centers and multistory car parks to charge a vehicle, and a price-conscious public who, however rich, is always seeking a bargain.

This year, Hong Kong abolished the tax waiver on electric vehicles. I can only imagine that's because Tesla sales became so significant that Big Auto cried hard behind the scenes that they were being hard-done-by. Of course, if they had done their job and actually worked on developing proper electric vehicles instead of concept cars and placeholders, they could have competed. Instead, they complained.

It worked. This year, Tesla has hardly sold a car. BMW and Mercedes sales are back up, and we get to continue breathing our incredibly smoggy air.

I hope Asian governments don't make the same mistake of "leveling the playing field" between cigarettes and next-gen devices. Actually, first of all they have to create a level playing field, since for now they largely ban next-gen nicotine products. In Hong Kong, the group investigating the issue of their introduction is "Smoke Free Hong Kong," so you can see where they're coming from. Their findings so far have been that using one of the devices is worse for you than breathing air, so ban them.

Of course, there are lots of things that are worse for you than doing nothing, such as drinking alcohol, eating KFC, and ice staking. Watch those blades.

If we waited for multigenerational studies of health risks before introducing products, the very first consumers would be getting their hands on a mobile phone around about now. It's taken until now to establish that they don't cause brain cancer, and even then people still have doubts. Nevertheless, the smartphone has changed the world, largely for the better, benefiting lives in many ways.

There's no doubt that cigarettes are very bad for you, deadly in fact. We're not so sure about vaping, e-cigarettes and heat-not-burn. But I'm just going to go with my gut feeling and common sense and say that inhaling vapor without combusted smoke is less bad for you. It's an easy choice, and one that many consumers make given that choice. Governments should let them, and investors should watch for that change.

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At the time of publication, Alex Frew McMillan had no positions in the stocks mentioned.

TAGS: Investing | Global Equity | Regulation | Markets | Consumer Discretionary | Consumer Staples | Emerging Markets | Earnings | China | How-to | Risk Management | Stocks

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