Session 3: Key challenges for global tobacco–the investor’s view

There was something refreshing—perhaps a little chilling—about sitting in on a panel comprising business analysts, a fund manager and a business consultant. This was a space for grown-ups, where a person could talk about a market’s having seen an increase in the rate of smoking without having to add a rider about how nobody wants more people to smoke.

So what should the audience take away from the third breakout session on the afternoon of day one of the Global Tobacco & Nicotine Forum, “Key challenges for global tobacco—the investor’s view”? Well, overall, there seemed to be a bullish mood in respect of the tobacco/nicotine industry, as well as the major companies operating within it, though it was acknowledged that the industry was not without risks.

There was talk of this being an attractive industry for investors with resilient volumes and increasing pricing power, especially compared with those of other fast-moving consumer goods (FMCG) companies. And the point was made that industry players were not as exposed as were those of other FMCG businesses to the sorts of risks posed to the retail environment by Amazon. The industry was seen as one built on a still-solid core of combustible cigarettes being driven along at an accelerating pace by an exciting, disruptive technology in the form of reduced-risk, next-generation products (NGPs).

There was much talk of the huge success that Philip Morris International’s (PMI) heated-tobacco product, iQOS, had enjoyed, especially in Japan where, at the end of August, it had captured 13.5 percent of the market. But despite this nearly unprecedented success, the panel was keen to see how iQOS and other such products would perform on other markets, especially those in Europe. One comment had it that comparing Japan’s market (where nicotine-delivering e-cigarettes are banned) with others, was like comparing night and day.

Questions were raised by panelists about whether PMI’s first-mover advantage in respect of heated-tobacco products had been overstated, and about what other types of NGPs might be commercialized in developing countries where electricity supplies might not be readily available universally. Panelists seemed to want to see offerings expanded so that NGPs were available at different price points, especially in countries throughout Africa, Asia and Latin America. And there was a sense of impatience about what was happening around products described by PMI as Platform 2 devices—products that don’t require recharging and that better replicate the rituals of smoking than do existing NGPs. From the floor of the session, one participant suggested that if the big manufacturers failed to launch Platform 2-type products, others might. Generally, it was said that companies had to ensure they had coherent strategies for NGPs.

With a few exceptions, the combustible-cigarette, excise-tax regimes of countries were seen as being benign—there weren’t any poor, committed smokers in the room—and the illegal trade risk was seen as manageable. Given rational pricing and rational competitive behavior, combustible cigarettes were going to remain the basis of what was an attractive business.

While it seemed inevitable that excise taxes would increase on NGPs, for the moment they were lower than were those on combustibles, and this differential was allowing companies to invest more, and more rapidly, in the development of NGPs. The NGP business model was seen as sound as long as taxes on these products did not go above taxes on combustibles, something that was thought to be unlikely.

The announcement in July by the U.S. Food and Drug Administration that it would require the reduction of cigarette nicotine deliveries to nonaddictive levels if that were found to be technologically and practically feasible was seen as potentially negative in respect of those companies exposed to the U.S. market. However, it was thought that because of the research required, such a policy was unlikely to be instigated within the next five years, if at all.

Standardized packaging was not seen as a threat to combustible product volumes, but it was seen to discourage sales of premium products and to hamper the launch of line extensions. It was noted that, in the U.K., where standardized packaging has been introduced; it would not be a requirement in respect of iQOS, because that product did not meet the definition of a tobacco product.

Finally, the big mergers and acquisition question was: should/would PMI acquire Altria? And the answer was: yes, and no.