Big Tobacco's Final Frontier

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To most people, Philip Morris International (NYSE:PM) is synonymous with 'big tobacco' - everyone's favorite market villain.

Over the past decade, developed nations have declared an all-out war against the tobacco industry. By 2012, things looked grim for tobacco makers, as Europe - which accounts for 33% of the world’s smokers - got so tangled up in its debt crisis that people even cut down on cigarette purchases.

The EU then proposed graphic visual and written warnings to cover up to 75% of tobacco packages, up from its current 30%. It also proposed to ban slim and menthol flavored cigarettes, which are primarily marketed towards women. Similar moves were also executed in the United States, Australia and Japan, which reduced tobacco revenue signficantly.

But has Philip Morris International truly suffered?

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It sure doesn't look that way.

Philip Morris, which now has zero exposure to the American market after its 2008 spin-off from Altria (NYSE: MO), has actually been a juggernaut of growth despite these well-publicized setbacks. In other words, even though Americans have stopped smoking, the rest of the world hasn't.

Philip Morris has consistently found new markets of growth, and one of its biggest (and most controversial) markets is Indonesia, the final frontier of big tobacco.

Indonesia: The Final Frontier

Indonesia, the fourth most populous country in the world, is considered a key emerging market in Asia. Between 2009 and 2011, the country’s GDP per capita has steadily risen from $4,300 to $4,700, with overall GDP growth advancing at over 6% annually. That makes it the ideal market for Philip Morris, since 80% of all smokers come from low to middle-income countries.

Indonesians purchase an average of 181 billion cigarettes annually. Indonesia also has the world’s highest percentage of smokers - 36% of all Indonesians smoke, including 67% of men and 5% of women. Excise taxes are low, far below WHO recommendations, allowing smokers to buy a pack of 20 cigarettes for approximately $0.90.

Young women, who had previously avoided tobacco due to cultural taboos, are now also breaking with tradition and smoking. Andika Priyono, the head of Indonesia’s child protection agency, says that young Indonesian women have a new mantra regarding the “three Bs” of modern success: “Blackberry, braces, and black menthol (cigarettes).” As such, tobacco companies have begun targeting this demographic by featuring younger, affluent, urban women in their ad campaigns.

There are also no enforced age restrictions for purchasing tobacco in Indonesia. Between 1995 and 2010, the number of smokers between the ages of 10 to 14 rose from 71,000 to 426,000.

But is Big Tobacco to Blame?

However, are big multinational tobacco brands such as Philip Morris truly to blame for the rising number of Indonesian smokers? Or was the country already addicted long before they arrived?

The Indonesian population is poorly educated on the dangers of smoking. A popular Indonesian clinic even touts cigarette smoke as a cure to cancer and aging, offering “smoke therapy” sessions where smoke is blown into a patient’s ears and nasal passages as a medicinal treatment. Laws restricting outdoor smoking exist, but enforcement is nearly non-existent.

The tobacco industry employs over 237,000 people in Indonesia, and its excise taxes, while low, comprise an important stream of revenue for the government. Although international tobacco brands are often vilified for profiting in Indonesia, tobacco has always been a large part of Indonesian culture, and an integral part of its economy.

Kretek: The National Flavor

In 2005, Altria Group, the former parent company of Philip Morris, acquired Indonesia’s second largest tobacco company, Sampoerna. The deal was valued at approximately $5.2 billion, and allowed Philip Morris to expand into the lucrative Indonesian market.

90% of Indonesians prefer hand-rolled kretek cigarettes, which are made with a blend of tobacco and cloves. Philip Morris’ flagship Marlboro brand is the most popular non-kretek brand, with a 4% market share. By acquiring Sampoerna, Philip Morris was able to take over a variety of popular local kretek brands - such as Sampoerna A and Dji Sam Soe, unlocking a powerful new market. 

In just three short years under PMI management, Sampoerna overtook market leader Gudang Garam to become the largest tobacco company in Indonesia, claiming nearly a third of the entire market.  

Controversial Promotions

Last year, tobacco companies spent $200 million promoting music festivals, sporting events and school festivals in Indonesia, which has strengthened their brands throughout their countries. In developed nations, tobacco companies are barred from such promotional activities.

Regulatory Threats

Looking forward, Philip Morris faces anti-smoking activist groups in Indonesia, who are slowly but surely gaining traction. Additional controls for tobacco advertising are reportedly being considered by the Indonesian government, and new graphic warnings - similar to those in developed nations - have been added to cigarette packages. Health minister Nafsiah Mboi has also stated that she plans to push the country to sign the WHO’s global tobacco treaty. If successful, this could raise excise taxes significantly and increase restrictions.

The Foolish Bottom Line

To put Philip Morris International's growth into perspective, consider this - Altria, which is restricted to the U.S. market, posted 30% revenue growth over the past five years. Philip Morris International has posted 36% revenue growth in that same period by feeding off emerging markets. Between 2009 and 2011, Philip Morris International’s growth in Asia also rose from 21% to 29%, offsetting some losses in Europe.

In addition to its eye-popping return on equity ratio of 473%, dividend investors will also like Philip Morris’ hefty dividend yield of $0.85 per share - a 3.78% yield at current prices.  

Market villain or not, there's one thing that can't be ignored about Philip Morris - its fundamentals are smokin'.

Leo Sun owns shares of Altria Group and Philip Morris International. The Motley Fool has no position in any of the stocks mentioned. You can follow Leo Sun on Twitter at for more investing ideas.

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