Philip Morris PM’s investment in innovative new products could increase its competitive advantage versus sector peers.
The tobacco company is seeking to capitalize on its strong position within the cigarette segment through aggressive price rises, while becoming more efficient through a cost-reduction program.
Although regulatory risks remain in place, the stock could offer investment appeal after declining 2% in the last year.
Investing in reduced-risk products
Innovative next-generation products have the potential to catalyze Philip Morris through providing greater differentiation versus sector peers. For example, it is currently investing in a new e-vapor product ahead of a meaningful entry into the category later in the current year. It is developing the IQOS MESH heating technology, which is a patented product that eliminates the need for a manual replacement of the heating element in e-cigarettes.
The MESH heating technology also prevents the formation of formaldehyde in the aerosol of the e-cigarette at the end of cartridge consumption. This could make it less harmful than rival offerings, thereby appealing to increasingly health-conscious consumers. In addition, the technology is 30% more efficient compared to rival coil and wick systems at the same power level or the same size, which could improve the customer experience through reduced charging time being required.
Since the global e-cigarette market is expected to be grow at a compound annual growth rate of 21% through 2024, having a competitive advantage through the release of new products could rocket the company’s financial performance.
Pricing power
Although global cigarette volumes have fallen at an annualized rate of 2.3% in the last five years, they present Philip Morris with a growth opportunity. It owns six of the world’s top 15 cigarette brands. This includes the international sales of the world’s largest cigarette brand, Marlboro, which has a 9.7% global market share. The company plans to retain an aggressive stance on cigarette pricing in order to maximize its growth potential in what remains a relatively price-inelastic industry.
Additionally, it will adopt a focused innovation strategy that entails fewer, but more impactful, initiatives that can be deployed within the cigarette segment at short notice on a global scale. This strategy has helped to maintain a 27.4% share of global cigarette sales in the last year, while there has been a 44% success rate of new product launches in the previous fiscal year.
Threats
Regulatory risks continue to threaten Philip Morris’ long-term growth prospects. As well as tighter regulations on tobacco products, such as being banned in public places in some markets, there are also risks presented by next-generation products. For example, San Francisco recently banned e-cigarettes, while some countries may look to introduce nicotine concentration ceilings. Alongside this, there is scope for higher excise taxes on e-cigarettes. Currently, they are lower in many countries versus taxes levied on cigarettes. This is expected to change as the e-cigarette segment grows in size, with governments likely to seek to recoup lost taxes on falling cigarette volumes.
In response to regulatory risks, Philip Morris is putting in place a rigorous and transparent scientific pre and post-market assessment program that focuses on an evidence-based approach to determining regulations. This could influence the pace and trajectory of future regulations across cigarette and next-generation product segments. Additionally, the company is seeking to become increasingly efficient through a program that aims to reduce costs by $1 billion between 2019 and 2021. As part of this, it is aiming to improve manufacturing performance and deliver better asset utilization.
Outlook
The company’s investment in innovative next-generation products could lead to an improving growth outlook over the long run. Its pricing power within cigarettes, as well as its focus on efficiency, may help it to overcome continued volume declines.
In the next fiscal year, Philip Morris is forecast to post a rise in earnings per share of 8%. Since it trades on a forward price-earnings ratio of 15.3, it seems to offer fair value for money. Having disappointed in the last year, the stock appears to offer long-term return potential.
Disclosure: the author has no position in any stocks mentioned.
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