EUR 850.00 For Business Accounts Only

Morningstar | PM Updated Forecasts and Estimates from 09 Apr 2019

After a promising start, the adoption of iQOS, Philip Morris' heated tobacco platform, slowed materially last year, and investors are now questioning the future of the category. The slowdown should not be surprising, however, as history shows the diffusion of disruptive consumer products has rarely occurred in a straight line, with various consumer segments adopting new products at different rates. With the adoption of the first platform having plateaued at fairly low levels, however, we think more disruptive innovation is required if heated tobacco is to mitigate the impact off the decline in combustible volumes.Of all the e-cigarette incarnations, heated tobacco products most closely replicate the smoking experience and so should attract smokers looking for a less risky alternative, so we believe that Philip Morris' multiple premium over peers is appropriate because it has claimed a first mover advantage, at least temporarily, through the early commercialization of iQOS. However, there are still many unanswered questions about the evolution of heated tobacco. Much depends on the regulatory environment, and whether regulators publicly acknowledge that the category is safer than smoking. The FDA is expected to announce its opinion later in 2019. Margins are also a key concern. We think that with scale, heatsticks can be at least as profitable as premium cigarettes, but margins will depend heavily on the level of taxation, and our base case assumption is that heatsticks are taxed in most markets as tobacco products.One drag on category profitability is the low margins on devices. We estimate iQOS devices generate margins of approximately 10% at full price and breakeven when on discount. It does seem likely that devices will never be as high margin as the stocks, given the likelihood of the development of a razor-and-blade model, but pipeline products such as PMI's platform 2, the disposable heated tobacco stick branded as TEEPS, has the potential not only to avoid this profitability impediment, but also to reignite growth in a category that has caused both euphoria and disappointment amongst investors.