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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. Cigarette shipment volumes were down 2.4% in the fourth quarter of 2015, and 1% for the year. In order to combat the declining volumes against increasing regulatory control, excise tax hikes, and increasing health consciousness among people, Philip Morris raised prices in a majority of its key markets. The company recorded a pricing variance of $2.1 billion in 2015. In 2016, Philip Morris expects a pricing variance of ~6% of their 2015 net revenues.
- Innovations could drive volumes and ensure share gains
- Philip Morris has seen soft cigarette volume trends for the past few quarters, due to a general shift away from tobacco products, amid accelerating prices of cigarettes and worldwide anti-tobacco campaigns. While the fall in volume has moderated to 1% in 2015, compared to high decline rates in 2013 and 2014, the fall in volumes is expected to continue, and for 2016, the company predicts a 2% to 2.5% reduction.
- Keeping this in mind, the company has undertaken significant investment to expand its reduced risk products (RRPs) range, in particular iQOS -- a black pen-shaped device that heats a Marlboro-brand ‘heatstick’ containing tobacco.
- During FY 2015, the iQOS launch was expanded in Japan to reach 60% of the adult smoking population. In Italy, the expansion was extended beyond Milan to Modena, Rome, and Turin. It was further launched in major cities across Switzerland, and city launches were started in Bucharest, Lisbon, and Moscow. By the end of 2016, the company expects iQOS to be present in key cities in 20 markets globally.
- In most countries where iQOS is launched, the company received a favorable tax treatment for heatsticks, as compared to cigarettes. This enabled it to price it lower than cigarettes in certain markets, such as Switzerland. IQOS has also managed to achieve impressive retention rates of over 30%.
- Updates on the most recent results
- Philip Morris reported diluted earnings per share of $4.42 in 2015, down by $0.34 or 7.1% versus $4.76 in 2014. Excluding unfavorable currency of $1.20, reported diluted earnings per share were up by $0.86 or 18.1% versus $4.76 in 2014.
- In 2015, the company reported net revenues, excluding excise taxes, of $26.8 billion, down by 10.0%. Excluding unfavorable currency of $4.7 billion and the impact of acquisitions, reported net revenues, excluding excise taxes, were up by 5.8%.
- Moderating declines in cigarette industry volume, notably in the EU region, coupled with market share gains, enabled the company to record a full-year organic cigarette shipment volume decline of only 1%, the best performance since 2012. Of particular note were the performances of Marlboro and L&M, which grew cigarette volume by 0.9% and 3.9%, respectively.
- Philip Morris' Q1 2016 revenues and earnings missed analyst estimates. Reported revenues of $6.08 billion, missed estimates by over 4%. This was mainly due to a pricing variance of just $272 million, which was a massive decline from 2015 figures, when the lowest quarterly pricing variance was $466 million. Despite a weakening dollar, currency still played a dampener, negatively affecting the quarterly revenue and EPS. The EPS was also impacted by a 160 basis points fall in gross margins. The company increased its EPS guidance for the year to $4.40-$4.50, due to a lower foreign currency impact than anticipated. Philip Morris managed to increase its shipment volumes in three of its four markets. In Asia, the decline was primarily due to a 5.9% shipment decline in Indonesia, as a result of a weak economy and price increase of 11% in the quarter. Declines were also seen in the Philippines and Pakistan. An EU shipment volume increase reflects improving economies, a decline in illicit trade, and a lower prevalence of e-vapor products. Growth in Latin America and the Canada region was principally driven by Mexico, while slow growth in the EEMA region reflected economic and geopolitical uncertainty in Ukraine, and excise tax-driven retail price increases in Algeria and Russia.
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 2-4% 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, with a wide range of premium, mid-price, and low-price brands, comprised of international, as well as local brands. 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. While U.S. 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.
Their portfolio of international and local brands is led by Marlboro, the world’s best-selling international cigarette, which accounted for approximately 34% of their total 2015 shipment volume. In addition to this, PMI also has six of the top fifteen brands by volume globally such as L&M, Philip Morris, Bond Street, Chesterfield, Parliament, and Lark, which are sold in more than 180 markets globally.
In addition to the manufacture and sale of cigarettes and other tobacco products, PMI is engaged in the development and commercialization of Reduced-Risk Products (“RRPs”). RRPs is the term PMI uses to refer to products with the potential to reduce individual risk and population harm in comparison to smoking cigarettes.
The four divisions of Philip Morris International consist of the following four regional segments:
- European Union
- Eastern Europe, Middle East, and Africa (EEMA)
- Latin America and 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 Dji Sam Soe, Sampoerna, and U Mild in Indonesia; Champion, Fortune, and Hope in the Philippines; Apollo-Soyuz and Optima in Russia; Morven Gold in Pakistan; Boston in Colombia, Belmont, Canadian Classics, and Number 7 in Canada; Best in Serbia; f6 in Germany; Delicados in Mexico; Assos in Greece, and Petra in the Czech Republic and Slovakia, 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.
Reduced Risk Products (RRPs)
The company has undertaken significant investment to expand its reduced risk products (RRPs) range, in particular iQOS -- a black pen-shaped device that heats a Marlboro-brand ‘heatstick’ containing tobacco. During FY 2015, the iQOS launch was expanded in Japan to reach 60% of the adult smoking population. In Italy, the expansion was extended beyond Milan to Modena, Rome, and Turin. It was further launched in major cities across Switzerland, and city launches were started in Bucharest, Lisbon, and Moscow. By the end of 2016, the company expects iQOS to be present in key cities in 20 markets globally.
Declining tobacco consumption
Volume of tobacco products sales have been declining due to growing health consciousness among people about the extreme health risks of smoking. Governments have also been discouraging tobacco consumption through high excise duties and legislative controls such as 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
Tax regimes, including excise taxes, sales taxes, and import duties, can disproportionately affect the retail price of cigarettes versus other tobacco products, or disproportionately affect the relative retail price of their cigarette brands versus cigarette brands manufactured by certain competitors. Because their portfolio is weighted toward the premium-price cigarette category, tax regimes based on sales price can place the company at a competitive disadvantage in some markets. 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. Legislation, like that 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.
Significant regulatory developments will take place over the next few years in most of the markets, driven principally by the World Health Organization's Framework Convention on Tobacco Control (“FCTC”). The FCTC is the first international public health treaty on tobacco, and its objective is to establish a global agenda for tobacco regulation. The FCTC has led to increased efforts by tobacco control advocates and public health organizations to reduce the palatability and attractiveness of tobacco products to adult smokers.
Philip Morris' share repurchase program
PMI's strong cash flow has led to the firm conducting share repurchases. The company announced an $18 billion, three-year share repurchase program in August 2012. PMI spent 11.9 billion to repurchase 135.3 million shares through September 30, 2014. On account of the volatile currency environment, the company decided not to purchase any shares in 2015.
Trefis Forecast Rationale for Asia Cigarettes Market Volume
Asia Cigarettes Market Volume is the total market size of cigarettes in Asia (excluding China) in terms of the number of cigarettes sold per year.
Asia Cigarettes Market Volume was 1,147 billion in 2009 and had been growing at a steady rate. In 2010, its volume was around 1,164 billion. In 2011, the market volume grew to reach 1,182 billion and further to 1,193 billion units in 2012. However, the market volume has declined thereafter due to tax hikes and the prevalence of illicit cigarettes in the region. It reached 1,078 billion in 2015.
Going forward, we expect cigarette volume in Asia to decline modestly to reach around 1 trillion over the Trefis forecast period.
Trefis considered the following factors for its forecast:
- Increasing health consciousness
- After increasing around 1.5% annually until 2011, cigarette volumes have been declining in Asia at a rate of about 2%, as consumers become increasingly aware of the ill-effects associated with tobacco products, specifically in more developed Asian markets such as Japan, Australia, and South Korea. Growing health awareness in emerging markets may further exacerbate this decline.
- High excise duties and legislative controls
- Governments resort to various anti-tobacco legislations and anti-smoking laws to discourage tobacco and cigarette consumption. Existing and proposed legislations for ingredient disclosure and banning smoking in public places could lead to a decline in cigarette sales. For instance, the Tobacco Plain Packaging Bill in Australia, which was implemented in the country in December, 2012, requires all cigarette companies to sell their products within the country in generic olive-green packs with large graphic warning labels. Such bills could erode the brand value for cigarette companies, and can lead to a substantial reduction in sales. Furthermore, governments of other countries, such as India, are keeping a close watch on the bill, and may implement similar measures in their countries as well.
- Almost all state and local governments tax tobacco products for both revenue and public health purposes. High excise duties lead to an increase in cigarette prices which also discourage cigarette smoking. These excise taxes are almost 55% of revenues in Asia and keep gradually increasing every year.
- In January, 2013, the Philippines implemented the 'sin tax' law raising excise taxes on cigarettes sharply, which led to more than a 40% decline in cigarettes shipped by Philip Morris in the country. The law also requires sequential hikes in excise taxes till 2017, beyond which there will be a 4% hike annually.
- In the beginning of 2015, Korea implemented a 120% increase in total tobacco excise. In response to this, Philip Morris increased the price of key-brands, Marlboro and Parliament, by close to 67%.
- Japan has resisted tax hikes on cigarettes since 2012, they have been facing continued pressure by the World Health Organization (WHO) to hike excise by close to 50%. In this case, it may only be a matter of time until hikes are put in place even in this market, to hurt sales.
- WHO Framework Convention on Tobacco Control (“FCTC”) enforced since 2005, establishes a global agenda for tobacco regulation with several measures for reducing the initiation of tobacco use and encouraging cessation, thereby prompting a decline in demand for tobacco products. It has more than 170 signatory countries worldwide including all major Asian markets.
- Marketing restrictions and plain packaging restrictions could hurt volumes
- Cigarettes and other tobacco products face strong rules on advertising and marketing restrictions with compulsory health warnings on the packaging. Strong restrictions are also meant to prevent children and adolescents from getting influenced from any public marketing of tobacco products, which also constrain cigarette promotion for adult consumers, thereby leading to a fall in demand.
- Many countries are implementing plain packaging laws which prohibit colorful and graphic branding elements on the cigarette pack and replace them with graphic health warnings.
- In Australia, the consumption of cigarettes decreased by 12.2% year on year in December 2014. A plain packaging legislation that was enacted by the country was given the major credit for this decrease. If other Asian countries also implement such plain packaging laws, the sales could be hampered to reduce the market size.
Back to Company Overview
- Positive growth in some of the biggest markets
- The Indonesian market, which is the largest cigarette consuming nation in Asia (excluding China), is marked by several trends favorable to the tobacco industry like the high smoking prevalence rate (highest male smoking rate in the world at 67%), relatively lower cigarette prices, and increasing affordability led by rising income levels. Indonesia is among the few markets that has actually been seeing increasing industry volumes, which is expected to continue going into 2016. PMI witnessed a 0.1% growth in shipments in the country. A volume shift towards premium brands, rampant tobacco advertising, and relatively lenient government policies to reduce or check tobacco consumption, have also fueled the market growth.
- Another factor dampening anti-tobacco moves of the local government is the important role that the tobacco industry plays in the national economy. The country hosts the world’s fifth largest cigarette manufacturing industry that contributes almost 3% of total cigarettes consumed globally. The taxation of tobacco companies contributes around 10% to national revenue and also provides around 10 million jobs directly or indirectly. Devoid of any regulations, the market could go on to become a real winner for Philip Morris, especially when they have been consistently gaining market share.
- Lax regulations in developing countries
- Regulations are lax in developing economies and big tobacco firms often use their financial muscle influence rules in a way that suits them. Moreover, rising incomes and increasing social acceptance of cigarettes are fueling demand in the region.
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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