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Investment Overview for Philip Morris International (NYSE:PM)
WHAT HAS CHANGED
- Price hikes in a number of markets to combat declining volumes
- The tobacco industry, in general, is a declining one, where volume declines have been a regular feature. Between 2013 and 2014, while the overall market size declined 2%, volumes sales for Philip Morris International declined 3%. In order to combat the declining volumes against increasing regulatory control, excise hikes, and increasing health consciousness among people, Philip Morris hiked prices by about 2% in the year.
- Innovations could drive volumes and ensure shares
- While pricing has always been a key strategy to maintain profits, Philip Morris has channeled resources to ensure volume growth as well.
- 2014 witnessed a series of innovations and new launches in a number of key markets. This includes the launch of Marlboro Clear Hybrid (a regular to menthol capsule product), Marlboro Fusion Blast (Menthol product), iQOS (Reduced Risk Product), Dji Sam Soe Magnum Blue (machine-made Kretek product), to name a few.
- The introduction of these new products could allow Philip Morris International higher volume sales as they gain a higher share of the market.
- Updates on the most recent quarter
- In Q3 2015, Philip Morris posted strong currency neutral results, with revenues growing 5.9% to beat analyst estimates. This was achieved through strong pricing and share gains in key markets.
- In terms of the company's performance in specific markets, while the EU, EEMA, and Latin America and Canada displayed strong revenue and OCI growth, Asia showed some slack. This was guided by strong industry declines in Japan and Indonesia, which impacted volume sales.
Below are key drivers of Philip Morris International's (PMI) value that present opportunities for upside or downside to the current Trefis price estimate for Philip Morris International:
Philip Morris International Revenue per Cigarette in Europe and Asia and EEMA and Latin America & Canada - We currently estimate revenue per cigarette to annually increase by 5-6% in its various geographical segments. If however, the increase in each segment is half of our current estimate because of higher excise duties and lower pricing, it would imply a 10-12% downside to the Trefis price estimate.
Philip Morris International is a leading international tobacco company, encompassing eight of the world’s top 15 international brands, which includes Marlboro, the number one cigarette brand worldwide. Until the spin off in March 2008, Philip Morris International was an operating company of Altria Group. The newly independent Philip Morris International sells tobacco products in international markets while Altria maintains its operations in the US.
After the spin-off, PMI has become the world's leading international tobacco company and the third most profitable international consumer goods company. While US sales revenues have been in decline as Altria struggles to cope with higher state tobacco tariffs and the tobacco industry's negative image in the US, international sales continue to grow for PMI. Its portfolio has a wide range of premium, mid-price, and low-price brands, which include both international and local brands.
In addition to selling Marlboro branded cigarettes (the world’s highest volume cigarette brand), PMI also has seven of the top ten brands by volume globally such as L&M, Philip Morris, Bond Street, Chesterfield, Parliament, Lark, A Mild, and Morven Gold, which is sold throughout Europe, South America, Africa, and Asia.
In 2009, PMI acquired Swedish Match South Africa to gain a stronghold in the smokeless tobacco category. In 2010, Philip Morris Philippines Manufacturing Inc. (PMPMI), an affiliate of PMI, united with Fortune Tobacco Corporation (FTC) to create a new company PMFTC in the Philippines, with both PM and FTC holding an equal share.
The four divisions of Philip Morris International consist of the following four regional segments –
- East Europe, Middle East, and Africa (EEMA)
- Latin America & Canada
Philip Morris International largely serves "discriminatory consumers," who are concerned with where the tobacco was grown and the quality of the product they are purchasing, with brands like Marlboro, L&M, Parliament, Philip Morris, and Chesterfield. The firm also maintains a portfolio of three value company brands (Bond Street, Red and White, and Next) for the "value consumers" who are more concerned with the price of tobacco products. It also owns local brands such as A Mild and Diji Sam in Indonesia, Diana in Italy, and Assos in Greece, to take advantage of established brands as opposed to marketing new brands in some regions.
Most tobacco and cigarette businesses today follow a Price-Profit First Strategy and enjoy significant room for strong net pricing and margin expansion. With declining cigarette sales, Philip Morris International's revenues and profits are maintained through higher pricing, which is a key driver of its performance.
Philip Morris International benefits from significant geographic diversification, with good exposure to emerging markets, which have high growth, and developed markets, which have higher operating margins.
Declining tobacco consumption
Volume of tobacco products sales have been declining due to growing health consciousness amongst people about the extreme health risks of smoking. Governments have also been discouraging tobacco consumption through high excise duties and legislative controls like bans on public smoking and strict restrictions on the advertising and marketing of tobacco products and compulsory health warnings.
High excise duty on tobacco products as well as proposed anti-tobacco legislations
State and local governments tax tobacco products for both revenue and public health purposes. Such excise taxes are at times as high as 30-80% of revenues for cigarettes in different countries. Regular excise tax increases or unfavorable changes in the tax structure lead to increases in cigarette prices and a fall in demand.
Governments also resort to anti-tobacco legislation and anti-smoking laws to discourage tobacco and cigarette consumption. Legislations like those banning smoking in public places lead to a reduction in cigarette sales. Proposed bills for disclosure in different countries and those mandating plain (generic) packaging for tobacco products (like Tobacco Plain Packaging Bill, 2011 in Australia) result in the expropriation of tobacco companies trademarks.
The WHO Framework Convention on Tobacco Control (“FCTC”) enforced since 2005 with more than 171 signatory countries including the European Community, establishes a global agenda for tobacco regulation with several measures for the purpose of reducing initiation of tobacco use. This is expected to lead to a decline in demand.
Philip Morris' share repurchase program
PMI's strong cash flow has led to the firm conducting share repurchases. The firm has so far repurchased 449.4 million shares using more than $28 billion since 2009 till the end of 2013. In April 2010, it completed its 2008–2010 share repurchase program of $13 billion and in May 2010 it initiated a new three-year share repurchase program of $12 billion. In 2014, the company repurchased shares worth $3.8 billion. On account of the volatile currency environment, the company has decided to take a call on share repurchases in 2015 only later in the year.
Trefis Forecast Rationale for Philip Morris International Market Share in Asia
Philip Morris International's Market Share in Asia is the ratio of the volume of cigarettes sold by Philip Morris International to the total volume of cigarettes sold in Asia every year.
Philip Morris International's market share in Asia jumped to 24.2% in 2010 from 19.7% in 2009 with the merger of Philip Morris International and Fortune Tobacco Corp in the Philippines. In 2011 and 2012, the market share grew further to 26.5% and 27.3% respectively. However, in 2013, the company's market share in Asia declined to just 25.8% as it lost significant ground to its prime local competitor in the Philippines. In 2014, market share in the region declined to an estimated 25.8% as the company lost share in key markets such as Indonesia, Japan, and Korea.
Going forward, we expect the market share to decline slightly in the short term, but increase gradually to around 26% by the end of the Trefis forecast period with major gains in Japan, Indonesia, and potentially the Philippines.
Trefis considered the following factors for its forecast:
- Share Gains Expected In Japan Against Innovations
- Philip Morris holds close to 25% of the market in Japan. Although Japan has been challenging, we anticipate market shares to grow in the country. In 2013, Japan underwent consumption tax hikes, which translated into unit price hikes. In response to this, Philip Morris experienced share losses of one percentage point, as customers traded down to cheaper alternatives to some extent.
- In order to stabilize market shares going into 2014 and 2015, Philip Morris resorted to new campaigns such as the Don’t Be A Maybe, Be Marlboro campaign. Furthermore, 2014 saw new launches for Marlboro and Lark. Against these, Philip Morris was successful in stabilizing market shares.
- We expect further market share gains in Japan in 2015 against further innovations. Market share going forward stands to benefit from the recent launch of Marlboro Fusion Blast, "a menthol cigarette with two different capsules that provide novel taste sensations," and through the full roll-out of iQOS, a type of smokeless cigarette. Going forward, Philip Morris plans to incorporate a range of colors and textures in this realm, to create greater appeal for the product.
- Philippines could see share gains in spite of headwinds
- In 2010, Philip Morris International merged with Fortune Tobacco Corporation to form a new company called PMFTC to control a large chunk of the Philippines tobacco market. In spite of a decline in the total cigarette consumption in the country in 2011 and 2012, Philip Morris continued to consolidate itself in the market.
- 2013 witnessed a growing prominence of economy brands, which adversely impacted Philip Morris' almost monopolistic hold in the market as consumers increasingly down-traded to competitor's brands in lower price points. Philip Morris faces intense competition from a local competitor, Mighty Corp., who landed 24% of the market from single digits since 2013, while Philip Morris went from 90% to about 70% share.
- 2013 also witnessed a sin tax law, which resulted in an increase in the unit price of cigarettes. The higher prices of Philip Morris' brands against increasing taxes, and as an attempt to mitigate losses from volume declines, has also resulted in share losses to a growing illicit market.
- In spite of these developments, Philip Morris could see some share gains going forward, albeit slowly. This is because, although 2014 saw increases in Philip Morris and the competition's unit prices, in a way that the price differential between the two has been reduced. In this situation, customers could trade up to a better and more renown brand going forward.
- Growth prospects in the large Indonesian market
- The Indonesian cigarette market constitutes approximately 25% of the Asian cigarettes market by volume. PMI occupies more than a third of Indonesia's market and ties up with local heritage brands like Sampoerna A and Dji Sam Soe to maintain a broad and deep product portfolio to compete effectively across all price segments.
- Indonesia is among the few markets that has actually been seeing increasing industry volumes, growing 1.9% in 2014 to 314 billion units, which is expected to continue going into 2015. Philip Morris experienced consistent growth in the region, with market shares reaching 35.3% by the fourth quarter against strong performance of the machine-made kretek brand, Dji Sam Soe Magnum, which blends tobacco, cloves, and other flavors.
- 2014 also saw the launch of Dji Sam Soe Magnum Blue. Going forward, increasing popularity of the kretek segment, along with further innovations, could guarantee share gains for Philip Morris. However, the market continues to remain vulnerable to legislations that could ban the use of flavor additives to cigarettes.
Back to Company Overview
- Lower market share in Korea against massive tax hikes
- Philip Morris International has been witnessing strong growth in South Korea, led by the Marlboro and Parliament premium brands. Shipment volumes grew by 100% between 2006-2010 and market share doubled from 8.5% in 2006 to 19.8% in 2011. In 2012, the company cut the price of its Virginia Slim cigarettes by 14% to extend its market share in the country. In 2013 and 2014, market share remained more or less flat at 19.4%.
- Going forward, we expect both the total cigarette market and Philip Morris' share in the market to shrink. In December 2015, the government introduced a Revised Tobacco Business Act, which requires manufacturers to change brand names and introduce cigarettes with lower ignition properties, with the aim of reducing the incidence of smoking. Furthermore, effective January 1st, Korea will see a 120% increase in total tobacco excise tax. In response to this, Philip Morris plans to increase the price of key-brands, Marlboro and Parliament, by close to 67%. These price hikes are expected to drag down the market by close to 20-25%. Philip Morris stands to lose significant share to illicit producers and other cheaper alternatives in the market.
- Anti-tobacco legislation
- Legislations for ingredient disclosure and a ban on smoking in public areas in different countries may hurt cigarette sales. The Tobacco Plain Packaging Bill in Australia, which was recently approved by the country's Supreme Court, requires all cigarette companies to sell their products within the country in generic olive-green packs with large graphic warning labels. This will cause erosion of brand value for the cigarette companies, and can lead to a substantial reduction in sales and market share. Further, governments of other countries, such as India, Canada, and the U.K., are keeping a close watch on the bill, and may implement similar measures in their countries as well.
How Does Trefis Modelling Work?
How do we get the historical numbers for this chart?
Trefis has a team of in-house Analysts who gather historical data from company filings and other verifiable sources. When historicals are available, we explain how we got them at the bottom of the Trefis analysis section below.
Who came up with the Trefis forecast for future years?
The Trefis team of in-house Analysts considers a variety of factors when projecting any forecast. The rationale for our projections is explained in the Trefis analysis section below.
How does my dragging the trendline on the chart impact the stock price?
- We use forecasts for business drivers to calculate forecasted Revenues and Profits for each division of the company.
- We then use forecasted Profits in a Discounted Cash Flow (DCF) model to obtain the Price Estimate for the company.
See more on: DCF Methodology
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