Philip Morris Expects $1.2 Billion Profit from Smoking Alternatives

 Philip Morris International is increasing its investment in cigarette alternatives in order to expand sales into more countries, aiming next year to lead the tobacco industry’s move into reduced-risk products that could eventually replace traditional smoking.

The maker of Marlboro has become “increasingly confident” that the business will reach the high end of its expected range, contributing $700 million to $1.2 billion in profit by 2020, Chief Executive Officer Andre Calantzopoulos said Thursday at an investor presentation in Lausanne, Switzerland. The company plans to spend an additional $100 million this year on so-called next-generation products, bringing the total to $1.2 billion.

Philip Morris is investing more heavily behind IQOS, its heat-not-burn heated tobacco device, in an effort to stay ahead of competitors British American Tobacco and Japan Tobacco. Philip Morris expects the product to be on store shelves in 20 markets by the end of this year, with plans to expand sales to as many as 35 countries next year. With $1.5 billion earmarked for reduced-risk product development next year, the tobacco maker is betting that smokers will prefer heated tobacco technology over e-cigarettes because it feels more like smoking.

“We are more convinced than ever that these products have the potential to fundamentally transform our business,” Calantzopoulos said.

‘Early Days’

IQOS is a rechargeable electronic device that heats tobacco sticks called HeatSticks, which resemble half-length cigarettes. The New York-based Philip Morris said it will produce more than 32 billion HeatSticks next year, up from 7 billion this year, and could produce 50 billion by 2018. HeatSticks have an advantage over cigarettes because they are new products and are taxed at lower rates in some countries, the chief executive said. The cost of producing them is in line with that of regular cigarettes, and the next-generation business should be close to break-even in 2017.

According to the company, more than 1 million smokers have already switched to IQOS across the test markets of Japan and Italy. “We are still in the very early stages,” the Philip Morris CEO said.

As smoking rates decline in developed countries, pressure is mounting on the tobacco industry to find products that can replace cigarettes. Philip Morris estimates that global cigarette consumption in the industry is falling by 2% to 2.5% annually.

‘Unclear’

“It is still unclear which product or category will ultimately win,” Rupert Wilson, an industry analyst who advises investors in tobacco, said Wednesday at a conference in Brussels. “Someone will eventually come out with a product that represents a step change. Who will do it? I don’t know.”

Philip Morris shares fell 0.7% to $98.71 in New York on Thursday. Through Wednesday’s close, the company’s stock had risen 13% this year.

Slowing growth in the industry may lead to consolidation, and Imperial Brands Plc was cited by analysts at the conference as the most likely target. Imperial is one of the few tobacco companies to have said the heat-not-burn market does not look attractive, choosing to focus on e-cigarettes instead. It is also the smallest of the four tobacco companies operating on a global basis, although it has expanded in the U.S. through the acquisition of the Winston and Kool brands. Imperial said Thursday that it still expects to meet its full-year profit targets.

“Imperial has the weakest hand, so you’d have to say they are the most likely” to be acquired, Jonathan Fell of London-based investor Ash Park Capital said at the event.