Can Philip Morris' Low Risk Products Counter Industry Woes?

Philip Morris International Inc (NYSE:PM) has been struggling with lower cigarette volumes, due to reduced consumption rates. To worsen matters, the court recently issued an order which guides cigarette companies to endorse anti-smoking campaigns. Nevertheless, Philip Morris has been diverting its attention toward Reduced Risk Products (RRPs) to stay afloat in the tobacco industry.

Thanks to the challenges stemming from lower cigarette volumes, Philip Morris’ top- and bottom-lines missed the Zacks Consensus Estimates in the third quarter of 2017. Notably, this marked the company’s third consecutive period of earnings and sales miss.

Consequently, the company’s shares have dipped approximately 8% since it posted third-quarter results on Oct 19. Philip Morris’s shares have lost 9.8% in the past three months compared with the industry’s decline of 0.6%.

Let’s delve into the factors which have been impacting Philip Morris’s performance lately and the efforts undertaken to uplift the company’s performance.

Anti-Smoking Advertisements Reduce Smoking Rates

Despite a formidable decline in cigarette consumption in the past decade, smoking is still considered as one of the leading causes of death in the United States. Further, federal authorities claim that tobacco companies have not informed consumers about the dangers and addictive nature associated with smoking. As per the new court order, companies will be forced to acknowledge the perils of smoking through corrective advertisements circulated through television channels, newspapers, websites, store displays and cigarette packs. Further, the court directed Altria Group (NYSE:MO) and R.J. Reynolds Tobacco Co. to bear the expenses of the campaign.

Stringent regulations imposed by government authorities surrounding tobacco consumption have always posed challenges for major players such as British American Tobacco (NYSE:BTI) , Altria and Vector Group (NYSE:VGR) . Cigarette consumption rates have declined globally due to precautionary labels and higher tax rates. The recent order to roll out anti-smoking advertisements is a major step to restrict tobacco consumption. This is expected to lower revenue prospects for almost all the companies operating in the industry.

Industry Hurdles Hurt Q3 Results & View: Estimates Decline

During third-quarter 2017, Philip Morris’s net revenues were hurt by a 3.6% decline in combustible products. Total shipment volumes in this category also declined 4.1%. The downside stemmed from lower volumes in the EU, EEMA regions and in Latin America & Canada. As a result, total cigarette and heated tobacco unit shipment volume declined by 0.5% in the quarter.

Management lowered earnings guidance for 2017, due to the headwinds surrounding the industry. Earnings are now expected in the range of $4.75-$4.80, lower than the previous range of $4.78 to $4.93. Consequently, the Zacks Consensus Estimate for 2017 revised two cents downward in the past 30 days to $4.75.

Reduced Risk Products Expected to Uplift Performance

Nonetheless, Philip Morris’s RRPs performance has been impressive lately. Consumers have been showing increased preference for such products, which have a lower negative impact on health. During the third quarter, the company generated revenues of $947 million from RRPs, significantly higher than $212 million reported in the prior-year quarter. This has driven the company’s overall top-line results. Additionally, heated tobacco unit shipment volume of 9.7 billion units, reflected a radical improvement from 2.1 billion units recorded in third-quarter 2016.

Considering such upsides associated with RRPs, Philip Morris has been making aggressive investments to expand heated tobacco units or IQOS devices along with e-vapor products. Additionally, the marketing and technology sharing agreement between Philip Morris and Altria Group, which is currently under FDA’s review, is expected to boost the companies’ business in the forthcoming periods.

Philip Morris has been striving to adapt with the changing industry conditions to meet consumer needs as evident from the smokeless cigarette category’s performance. We hope that such efforts will help this Zacks Rank #3 (Hold) company to stay afloat amid tough industry conditions. You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

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