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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.
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 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 1147 billion in 2009 and has been growing at a steady rate. In 2010, its volume was around 1164 billion. In 2011, the market volume grew to reach 1182 billion and further to 1193 billion units in 2012. However, the market volume declined in 2013 due to the implementation of the disruptive "sin-tax" law in Indonesia. This decline continued into 2014 due to tax hikes and the prevalence of illicit cigarettes in the region.
Going forward, we expect cigarette volume in Asia to decline modestly to reach around 1.1 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.
- Effective January 1st, Korea will see a 120% increase in total tobacco excise. In response to this, Philip Morris plans to increase the price of key-brands, Marlboro and Parliament, by close to 67%. A price increase of this magnitude could exert a considerable negative impact on volumes, with the company anticipating a 20-25% decline in industry volumes going into 2015.
- 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.
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- 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, growing 1.9% in 2014 to 314 billion units, which is expected to continue going into 2015. 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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