Business / Corporate

Philip Morris says it doesn't want you to buy its cigarettes, but will IQOS help it survive?

by Tiffany Kary

Bloomberg

How can a company that tells people explicitly not to buy its products survive? That’s a question for Philip Morris International Inc., which recently unveiled a campaign to “unsmoke” the world.

The Marlboro maker reports first-quarter earnings on Thursday, giving investors the latest data on just how fast cigarette volumes are falling. With its public push to discourage smoking, Philip Morris isn’t fighting that trend. Instead, it’s ramping up focus on its IQOS heat-not-burn device, already sold in about 44 countries.

“It makes financial sense because the new business is more sustainable, a better product for consumers. I’ve never seen where there is a better product for consumers and the company ended up in a worse situation financially,” said Chief Operating Officer Jacek Olczak. “IQOS and combustible (cigarette) volumes, they are 100 percent correlated. We’re not afraid of cannibalization.”

Philip Morris, which hasn’t sold in the U.S. since a 2008 split from sister Altria Group Inc., has been leaning into anti-smoking at a time when the drop in cigarette volumes is accelerating. Globally, volumes are falling at about 3 percent to 4 percent annually, Bloomberg Intelligence analyst Kenneth Shea said.

The “Unsmoke” campaign sums its mission up thus: “If you don’t smoke, don’t start. If you smoke, quit. If you don’t quit, change.” Still, anti-smoking advocates say the company’s new marketing is a far cry from it giving up on cigarette sales altogether.

“Their actions tell a different story than their words,” said Caroline Renzulli from the Campaign for Tobacco-Free Kids. Her group photographed a billboard in Indonesia showing a new brand, and says ads there feature the word baru, which means new — a sign that Philip Morris is still putting some resources into traditional tobacco. Around 214,000 Indonesians die from tobacco-related disease annually, and Philip Morris controls about 34 percent of the cigarette market there, according to the group’s website.

Philip Morris Bold was registered in Indonesia in January, according to the World Intellectual Property Organization. When asked about the registration, Olczak said the company sometimes needs to change labeling on its cigarettes, such as to accommodate new health warnings, and that in general it has reduced new brand launches. The company doesn’t yet sell IQOS in Indonesia, though plans to test it in the future, he said.

“In all markets where we have IQOS we have put product introductions to zero,” Olczak said.

When asked if the company would ever separate IQOS from the cigarette business, Olczak said: “I don’t have to think about this today,” adding that “it’s a nice problem to have for the future.”

It might make sense. Declining businesses with liabilities are sometimes managed through spinoffs, and Philip Morris faces lawsuits in Israel, Canada and Nigeria that claim “billions” of dollars in damages related to tobacco use and exposure, according to its filings.

Altria took steps last year to hedge against Big Tobacco’s troubles — taking stakes in Juul Labs Inc. and Canadian cannabis company Cronos Group Inc. For Philip Morris, it’s banking its future on IQOS. Though sales are going well in some countries, it’s still trying to court the World Health Organization to embrace its push to help adult smokers switch. It’s also seeking approval from the Food and Drug Administration to sell IQOS in the U.S. If it succeeds, Altria has an agreement to market it. A separate application from Philip Morris also seeks to market it in the U.S. as a reduced-risk product.

Olczak himself says he couldn’t quit smoking until six or seven years ago. He had a child and his wife was very unhappy with his cigarette use, so he tried an IQOS prototype, which he says finally helped him kick the habit. The company is ready to put a “human touch” on the issue, telling anecdotes about how relieved some children were to see their parents quit cigarettes thanks to IQOS, he said.

The decline in cigarette volumes in many countries hasn’t spooked Philip Morris investors — shares have jumped about 30 percent this year.

And cigarette sales are growing in places such as Pakistan, the Philippines, Thailand and Turkey, the company’s most recent annual report shows. In Indonesia, they were flat. In some countries, Olczak said, a reduction in illegal trade has resulted in volume increases.

Roberto Pozzi, an analyst at Moody’s Investors Service, questions what Philip Morris will do if alternative products aren’t as profitable as expected. Unlike Altria, the company doesn’t have investments in wine and cannabis. “They say the margins are similar to traditional cigarettes for IQOS, but they don’t publish the data,” Pozzi said.

IQOS does have better margins, because of taxes, Olczak said. It’s taxed favorably compared with cigarettes in many countries, such as Japan. But margins could be hurt if regulators decide to do otherwise, the company has said in regulatory risk statements.

Philip Morris is also working on other devices, such as IQOS 2, which has a carbon heat source at the tip that generates heat without an electric system. It has been launched as a test in the Dominican Republic. Further commercialization plans are under way, but have yet to be announced. Another possible path, Olczak said, is using the product as a medical device, or for nicotine replacement therapy.