Tobacco
`Latest Consumer Anecdotes Still Consistent: iQOS and JUUL Stand Out
`
`INDUSTRY NOTE
`February 14, 2018
`
`Michael S. Lavery
`Sr. Research Analyst, Piper Jaffray & Co.
`212 284-9511, michael.s.lavery@pjc.com
`
`Related Companies:
`BATS LN
`PM
`
`Share Price:
`44.40
`102.54
`
`Prices as of the close February 14, 2018.
`INDUSTRY RISKS
`
`regulatory action, especially
`Unfavorable
`disruptive excise
`tax
`increases, growth
`in
`illicit trade, currency movements, and general
`macroeconomic erosion.
`
`CONCLUSION
`We have been struck by two reduced risk products that appear to stand out so far in terms
`of consumer traction: iQOS from PMI and JUUL vapor (BAT's glo is promising, too, but does
`not yet have a track record comparable to iQOS). While we are careful not to extrapolate
`too much from anecdotes, recent consumer input reminds us that iQOS travels well, and
`that it likely has more pockets of strength outside Japan than is often appreciated.
`
`iQOS travels more than one may think: Discovering local users in NYC. We recently
`encountered iQOS users on the streets of Midtown Manhattan. When asked about the
`device, the first 20-something user indicated she purchased it in China and had stocked
`up on HeatSticks to bring back home to New York. A companion indicated that her father
`(in Korea) was a 20 year smoker who recently switched to iQOS. The excitement of the
`group around the product was palpable. A third member of the group proudly volunteered
`that iQOS was popular in Italy, too, where she had discovered it.
`
`China sales remind us that iQOS travels, likely via Japan. While China is not (yet)
`an iQOS launch market, we believe sales there (and in Hong Kong we hear about, too)
`are likely diverted product from Japan. If so, it makes us less concerned about potential
`trade loading in Asia; we conservatively model 1Q18 volumes, but there could be upside
`to our estimates if demand is driven in part by diverted sales. While sell-through in Japan
`remains robust (and growth has yet to slow down), to the extent it may also be a conduit
`to other markets, we believe momentum in Japan is likely to remain strong.
`
`Anecdote from Italy suggests pockets of strength. Sales in Italy remain relatively
`small, with national market share just breaking 1% in 4Q17, but we believe a consumer
`description of iQOS as popular there is consistent with our view that shares in some
`areas are much higher (we estimate share in Milan is likely over 5%; chart inside). We
`believe the product is likely becoming increasingly visible and/or prominent in at least
`some social circles, given a consumer touting its popularity and its rapid market share
`acceleration, from 0.7% in 3Q17 to 1.2% in 4Q17 (a ~70% sequential volume increase).
`
`iQOS and JUUL stand out on adoption rates, growth. We believe current smokers
`looking to switch to less harmful products are interested in nicotine delivery and taste.
`We believe the two products with the clearest traction to date are PMI's iQOS and JUUL
`vapor, a privately held US company that has also faced capacity constraints over the
`past year and has had ~20% sequential monthly growth rates. Both appear to have
`compelling nicotine delivery for smokers looking to switch (JUUL's mission is to eradicate
`smoking, and PMI is 'designing a smoke-free future'), and both have high adoption rates
`accordingly. Interest (per Google trends, shown inside) has risen sharply for both, too.
`
`US anecdote: JUUL fulfills a New Year's resolution; taste matters. We recently heard
`from a longtime smoker who paired a New Year's quit-smoking effort with switching to
`JUUL. With some limited dual use, tapering off over time, the effort was successful,
`in part because cigarettes started tasting 'worse and worse.' Armed with just enough
`persistence to use JUUL regularly enough to get acclimated, taste preferences started to
`adjust and the harshness of cigarettes became less and less attractive. PMI has reported
`the same progression for typical iQOS users. (JUUL scanner data chart inside.)
`
`Piper Jaffray does and seeks to do business with companies covered in its research reports. As a result, investors should be aware
`that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only
`a single factor in making their investment decisions. This report should be read in conjunction with important disclosure information,
`including an attestation under Regulation Analyst certification,
` found on pages 5 - 7 of this report or at the following site:
`http://www.piperjaffray.com/researchdisclosures.
`
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`

`

`I N D U S T R Y N O T E
`F e b r u a r y 1 4 , 2 0 1 8
`
`
`
`
`Exhibit 1
`iQOS and JUUL Google trends
`100
`90
`80
`70
`60
`50
`40
`30
`20
`10
`0
`
`JUUL
`
`iQOS
`
`Similar consumer
`interest for iQOS
`and JUUL
`
`Source: Google Trends, Piper Jaffray & Co
`
`Google Trends views worldwide interest in real time and indexes the interest of two products
`against each other. We paired JUUL against iQOS and found that both have accelerated in a
`similar pattern over the last couple years, with sharply growing interest in both products.
`
`
`Exhibit 2
`Estimated breakdown of iQOS share trends in Italy
`
`Italy
`National share
`Initial launch area share
`Percent coverage
`First expansion area share
`Percent coverage
`Next expansion area share
`Percent coverage
`Total launch area share
`Percent coverage
`
`4Q17
`3Q17
`2Q17
`1Q17
`4Q16
`3Q16
`2Q16
`1Q16
`0.0% 0.1% 0.1% 0.3% 0.5% 0.6% 0.7% 1.2%
`0.2% 0.3% 0.5% 1.5% 2.5% 2.8% 3.0% 5.3%
`20.0% 20.0% 20.0% 20.0% 20.0% 20.0% 20.0% 20.0%
`0.1% 0.2% 0.3%
`44.0% 44.0% 44.0%
`0.1% 0.2%
`9.0%
`9.0%
`0.2% 0.3% 0.5% 1.5% 2.5% 0.9% 1.0% 1.6%
`20.0% 20.0% 20.0% 20.0% 20.0% 64.0% 73.0% 73.0%
`
`
`
`
`
`Italy likely has initial
`launch area share
`above 5%
`
`
`Note: We assume expansion area share trends mimic those of the initial launch area s history. Source: Piper Jaffray & Co
`
`Italys national share rose from 0.5% in 1Q17 to 1.2% in 4Q17, but its footprint grew from 20% of
`the country to 73% in 3Q17, which means that it added lots of territory with very little initial share.
`(We assume a similar 73% launch area coverage in 4Q17, though PMI has not disclosed an
`updated figure.) We estimate its initial launch area share (essentially Milan) grew from 2.5% in
`1Q17 to 5.3% in 4Q17, reflecting more strong momentum locally than its national share suggests.
`On the following page, we compare this progression to other launch areas, including in Japan, and
`find that the share trajectory momentum following an initial launch area share of ~0.5% is similar
`across many launch areas worldwide.
`
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`

`

`I N D U S T R Y N O T E
`F e b r u a r y 1 4 , 2 0 1 8
`
`
`
`Exhibit 3
`iQOS share trend comparisons, Japan cities vs. initial launch areas in European markets
`8%
`
`7%
`
`6%
`
`5%
`
`4%
`
`3%
`
`2%
`
`1%
`
`0%
`
`Nagoya
`
`Tokyo Bucharest Athens
`
`Lisbon
`
`Milan
`
`Q1
`
`Q2
`
`Q3
`
`Q4
`
`Q5
`
`Q6
`
`Note: Key cities are used to identify initial launch areas which can include other cities. Source: Piper Jaffray & Co
`
`
`
`Launch area trends
`point to promising
`potential
`
`
` or exceed Japans trends, if using the first quarter
`Launch area share trajectories closely mirror
`with a ~0.5% market share as a starting point for comparison. We consider this starting point to be
`relevant as it reflects sufficient local awareness. Using that quarter as quarter one and then each
`following quarter as quarter two , etc., we see faster relative momentum in Athens, Bucharest and
`Lisbon than we saw in Nagoya and Tokyo. Athens reached 0.5% in its launch quarter and only has
`five periods since of history since launching.
`
`Exhibit 4
`JUUL 4-week retail sales
`$50
`$45
`$40
`$35
`$30
`$25
`$20
`$15
`$10
`$5
`$0
`
`JUUL retail sales
`soar in 2017
`
`Source: IRI, Piper Jaffray & Co
`
`JUULs 4 -week sales growth grew over 800% in 2017, with under $5M in sales during the 4 weeks
`ending mid-February 2017 and over $46M in the 4 weeks ended mid-January 2018.
`
`
`
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`

`

`I N D U S T R Y N O T E
`F e b r u a r y 1 4 , 2 0 1 8
`
`
`
`British American
`Tobacco (BATS-
`LON)
`
`Philip Morris
`International (PMI)
`
`We rate BATS LN Overweight. Our target price of £61 applies a ~17.5x multiple to our 2019E EPS
`of £3.50. We expect BATS to deliver 8-9% three-year average organic sales growth and 12-13%
`average EPS growth. Risks: Disruptive excise taxes, macro pressure, and currency moves may
`pose risks to profits.
`
`
`We rate PM Overweight. Our target price of $126 applies a ~22x multiple to our 2019E EPS of
`$5.75. We expect PMI to deliver 8-9% three-year average organic sales growth and 11-12%
`average EPS growth. Risks: Unfavorable regulatory action, especially disruptive excise tax
`increases, a stronger US dollar and the growth of counterfeit products could pose a risk to upside
`to the shares.
`
`
`
`
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`

`

`IMPORTANT RESEARCH DISCLOSURES
`
`INDUSTRY NOTE
`February 14, 2018
`
`Notes: The boxes on the Rating and Price Target History chart above indicate the date of the fundamental Equity Research Note, the rating and the price
`target. Each box represents a date on which an analyst made a change to a rating or price target, except for the first box, which may only represent the
`first Note written during the past three years.
`
`Legend:
`I: Initiating Coverage
`R: Resuming Coverage
`T: Transferring Coverage
`D: Discontinuing Coverage
`S: Suspending Coverage
`OW: Overweight
`N: Neutral
`UW: Underweight
`NA: Not Available
`UR: Under Review
`
`Rating
`BUY [OW]
`HOLD [N]
`SELL [UW]
`
`Distribution of Ratings/IB Services
`Piper Jaffray
`
`Count
`383
`264
`20
`
`
`
`Percent
`57.42
`39.58
`3.00
`
`IB Serv./Past 12 Mos.
` Count
`Percent
`
`102
`26.63
`
`24
`9.09
`
`0
`0.00
`
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`

`

`INDUSTRY NOTE
`February 14, 2018
`
`Note: Distribution of Ratings/IB Services shows the number of companies currently covered by fundamental equity research in each rating category from
`which Piper Jaffray and its affiliates received compensation for investment banking services within the past 12 months. FINRA rules require disclosure
`of which ratings most closely correspond with "buy," "hold," and "sell" recommendations. Piper Jaffray ratings are not the equivalent of buy, hold or sell,
`but instead represent recommended relative weightings. Nevertheless, Overweight corresponds most closely with buy, Neutral with hold and Underweight
`with sell. See Stock Rating definitions below.
`
`Analyst Certification Michael S. Lavery, Sr. Research Analyst
`The views expressed in this report accurately reflect my personal views about the subject company and the subject security. In addition, no part of my
`compensation was, is, or will be directly or indirectly related to the specific recommendations or views contained in this report.
`
`Piper Jaffray research analysts receive compensation that is based, in part, on overall firm revenues, which include investment banking revenues.
`
`Time of dissemination: 14 February 2018 22:42EST.
`
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`

`INDUSTRY NOTE
`February 14, 2018
`
`Research Disclosures
`Piper Jaffray usually provides bids and offers for the securities of British American Tobacco plc and will, from time to time, buy and sell British American
`Tobacco plc securities on a principal basis.
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`and sell Philip Morris International Inc. securities on a principal basis.
`
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