Forecasting An End Of Cigarettes, Philip Morris Launches iQOS In The UK

Tobacco giant Philip Morris International (NYSE:PM) launched its potentially reduced-risk tobacco product, iQOS, in the UK on November 30th. This product is a black pen-shaped device that heats tobacco, instead of burning it, in an effort to reduce the harmful effects of smoking. Since it heats the tobacco, it generates no smoke or ash, just a vapor containing nicotine. This device is already available for sale in over a dozen markets, including Japan, Italy, and Switzerland. Chief Executive Andre Calantzopoulos also claimed that conventional cigarettes could become a thing of the past, and predicted a “phase-out period” for cigarettes. The new iQOS product, with fewer toxins, could eventually replace cigarettes in the long term.

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iQOS is the result of more than a decade of research on a range of potentially reduced-risk products, which can prove to be an alternative to traditional cigarettes. The research, conducted by over 430 scientists in Philip Morris’ R&D facilities in Switzerland, involved an investment of $3 billion by the company. According to the company’s research, the device yields on average, less than 10% of the harmful constituents found in cigarette smoke. However, despite the growing awareness and publicity with regards to vaporizers and e-cigarettes, this segment still remains an insignificant part of tobacco firms’ income. PMI also expects its Reduced Risk Products (RRPs) to approach break-even OCI (Operating Companies Income) in 2017, and to start contributing positively by 2018. The company is targeting 30 to 50 billion units in incremental volume through RRPs, which would add an additional OCI of $0.7 billion to $1.2 billion by 2020, with an increasing confidence of reaching the upper end of the target range.

There are plans of increasing the annual RRP production capacity to 50 billion units, an increase of 20 billion units from its initial planned capacity of 30 billion units, by the end of 2017. The heated tobacco stick capacity is anticipated to be 7 billion units, available for commercialization, in 2016 with an installed annual capacity of 15 billion units by the end of the year. iQOS should be present in close to 20 markets by the end of 2016, and in 30 to 35 markets by the end of 2017. According to a Wells Fargo analysis of the iQOS platform, the product has the potential for expanding the profit pool growth of combustible cigarettes and RRPs in the next decade by 400 basis points, to a 12.5% CAGR for Philip Morris. 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.

Japan is the only country where the national roll-out of iQOS has occurred, and it has witnessed exceptional performance. The market share has steadily climbed since it was first introduced in the country. During FY 2015, the iQOS launch was expanded in Japan to reach 60% of the adult smoking population, and the national roll-out was completed in the beginning of the second quarter. For the third quarter, the HeatSticks market share increased to 3.5%, an increase of 1.3 points, compared to the second quarter. Furthermore, the share in the last week of September, reached an estimated 4.3%, and an even higher 7.3% in Tokyo, despite limited expansion due to supply constraints. According to the latest data supplied by the company, the weekly market share increased to 4.9% in October. If the country is able to replicate the success it has found in the country elsewhere in the world, it will prove to be a big revenue generator in the future for Philip Morris.

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