Philip Morris International Q4 2014 Earnings Preview

In our pre-earnings report on Philip Morris International (NYSE:PM), we focus on its largest markets and some high impact expense items. Markets such as Russia, Europe, Latin America and South-East Asia helped drive the company’s performance in the previous quarter. Certain expenses related to new product launches, changes in the brand architecture and the optimization of the manufacturing footprint may continue to pressure the earnings.

We have a price estimate for Philip Morris’ stock price of around $80, which is slightly lower than the market price.

See Our Complete Analysis For Philip Morris International

A Survey Of International Cigarette Markets

Philip Morris earns revenues from across the world, so it is important to understand the trends in the various markets it serves. The Eastern Europe, Middle East and Africa (EEMA) region stood out in Q3, with PMI seeing both market share and pricing improvements.

The largest contributor to the improvement in EEMA was Russia. ^[1] The improvements in the margins in Russia was facilitated by an excise tax increase. This masked the disproportionate hike in the prices. This in turn led to a reduction in the industry market size to the tune of 10% in 2014. ^[1] Philip Morris, however, was able to increase its market share in the face of this decline. It could do so because it made a strategic investment in Megapolis, which has a near monopoly in Russia’s cigarette distribution. Philip Morris has also agreed to pay Megapolis up to $100 million based on its performance. This may have helped it gain market share in Q4 2014 as well. However, the troubled domestic economy poses a risk to cigarette companies in Russia.

The company also saw a strong performance in Latin America, as profit momentum in the region was driven by price increases. ^[1] New research, however, reveals that the rising prices have a significant adverse effect on cigarette purchase volumes in Latin America. In Argentina, Chile and Mexico, a doubling of prices is expected to reduce cigarette consumption by around 20% in the short run and around 35% in the long run. For Uruguay and Brazil, these estimates are 40% and 90%, respectively (mid-range figures have been taken instead of ranges). ^[2] Adding to this is the economic downturn experienced by several Latin American countries in late 2014. Their currencies weakened against the U.S. dollar and many of them have cut their growth forecasts. ^[3] It remains to be seen whether Philip Morris continued its Q3 2014 performance in the region in the fourth quarter.

Europe was another strong performer for Philip Morris in Q3 2014. Despite being the largest revenue generator, this division is not the largest contributor to our valuation of the company. This is on account of the declining trend in the smoking rate, a trend which is expected to persist into 2015, despite certain price hikes in Germany. The first three quarters also saw Philip Morris gain a 1 percentage point increase in market share. This is believed to be on account of the acceptance by consumers of the Marlboro 2.0 brand architecture. This could benefit the company in Q4. ^[1]

The last market to focus on is Southeast Asia. Here we take a look at Indonesia and the Philippines. The volatile Indonesian cigarette market registered better than forecast sales for the company in Q3 2014. In addition to demand, the closing of price gaps by competitors helped the company in this regard. These products have crossed the critical price point of IDR 12,000 per pack, at which they lose the benefit of being cheaper than PMI’s Dji Sam Soe brand. ^[1] The improvement was also aided by Philip Morris’ extension of this brand from hand rolled cigarettes to machine made products (See Our Earlier Article On PMI In Indonesia).

In the Philippines, Philip Morris seems to backing off in the face of intense competition. It has announced that 13% of its workforce will be laid off. This is part of its manufacturing restructuring plan, which was necessitated by declining demand. This decline was due to the presence of illicit cigarettes and increased excise taxes. ^[4] In its Q3 earnings call, the company claimed that its rival, the Mighty Corporation, is reporting less than half of its actual sales. This is leading to a decline in the tax paid on cigarette sales, while consumer surveys show resilience in the consumption of cigarettes.  ((ref:1))

A Word On Expenses

The company had warned that certain expenses incurred in Q3 2014 would continue into Q4 as well. The costs associated with the commercialization of the Marlboro Red 2.0 brand architecture is one among them. As part of the revamp of the brand identity, several product level changes were introduced to the brand. These changes include redesigned packs and filters. The commercial roll-out of these products and the associated marketing expenses are expected to weigh on Q4 2014 earnings for Philip Morris. ^[5]

Another area of focus is the cost involved in the commercialization of reduced risk products. While a pilot plant for market study purposes has been built, the construction of a large scale facility for commercialization of these products is still ongoing. These facilities, located near Bologna in Italy, are expected to cost around €500 million. There are also sales and marketing expenses related to the roll-out. The national roll-out of these products in Italy and Japan, the IQOS e-cigarettes and heat-not-burn sticks, is slated for 2015. They are being introduced in the cities of Nagoya, Japan and Milan, Italy currently. The results from these cities will also be something to watch out for in the Q4 results. ^[6]

The manufacturing network restructuring costs that reduced earnings in Q3 are also expected to have an impact in Q4. The biggest component of this is costs associated with the shutdown of a plant in the Netherlands. These costs relate to the write-down of property, the logistics involved in shifting production and the termination of employee contracts. This shutdown is important because this was Philip Morris’ largest plant in the world. ^[6]

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1. Philip Morris Q3 2014 Earnings Call Transcript [↩] [↩] [↩] [↩] [↩]
2. The Impact Of Prices On The Use Of Tobacco Prices In Latin America [↩]
3. Economic Snapshot For Latin America [↩]
4. Philippine Affiliate Of Philip Morris To Trim 13% Of Workforce [↩]
5. Philip Morris Q3 Along Expected Lines [↩]
6. ref:11 [↩] [↩]