With fewer smokers, the total number of cigarettes sold continues to decline. But manufacturers offset those declines by exercising tremendous pricing power - a dance that has lasted decades. Those very same companies, in aggregate more profitable than ever, continue to invest in new types of nicotine products to reshape the world and reinforce their place in it. That is the heart of NEoN - The New Era of Nicotine.

Sitting at the forefront of this pivotal shift are 2 companies, Philip Morris International $PM and British American Tobacco $BTI. Both reported their full-year 2022 results this past Thursday, 2/9/2023, and reactions were just as mixed as the numbers.

Let’s dig in.

It was in 2012, a decade ago and only 4 years since being spun off from Altria, that Philip Morris International saw its cigarette volumes peak. In the years following, it remained uncertain how well RGM and pricing strategies would work, with certain international markets having different income dynamics compared to the West. This was compounded by the company investing in a first-of-its-kind heated tobacco product, IQOS. Not only were there serious doubts as to how receptive consumers would be, but the economics seemed questionable - especially when so many argued that a new product would quickly cannibalize the company’s immensely lucrative cigarette volumes.

It only took a few short years for IQOS to take the world by storm. While PMI’s cigarette volumes have been near flat for 3 years, HTU volumes have become a growth driver, leading to 2 consecutive years of total volume growth.

Throughout 2022, along with impaired operations in Russia and Ukraine, PMI continued to face input inflation, supply chain issues, and other unfavorable macro dynamics. Even so, PMI’s total cigarette volumes were down -2.75% in Q4 and just -.47% for the full year. The company’s flagship brand, Marlboro, saw volumes increase by nearly 2% for the year. In total, the company saw a favorable +4% to price/mix.

While cigarette volumes remained just shy of flat, heated tobacco units continued their growth streak. HTU volumes were up 26% in Q4 and 15% for the year. In total, PMI captured 40bps of the total international market in 2022.

The shift to positive volume growth, while special, still understates the impact IQOS Heated Tobacco Units are having.

IQOS HTUs, with recognized reduced-risk properties that will ultimately lead to higher CLV, are broadly taxed at lower rates than legacy combustible products. This leads to a substantially higher net revenue contribution on a per-unit basis.

And the newest IQOS model continues to show strength with a higher conversion rate, leading to sustained growth in IQOS users:

Even in Japan, where HTP penetration is the highest of any market, ILUMA has reversed 5 quarters of decelerating growth:

And even in low and middle-income markets, IQOS has continued to take meaningful share year over year: