Australia And Europe Will Weigh On Philip Morris’ Earnings

Philip Morris International (NYSE:PM) is set to announce its third quarter earnings on October 18^th. The global tobacco giant reported mixed results in the previous quarter. It reported strong y-o-y volume growth of 8.2% in Asia. This excludes Japan, where it had extraordinary results in 2011 due to the tsunami impacting rival Japan Tobacco’s shipments in the country. However, it reported a 9.4% decline in volumes in Europe where the total cigarette market size fell 9.7%. Overall, revenues net of excise fell 2.7% despite an increase in pricing across all regions.

See our full analysis for Philip Morris

We believe the company will face a similar volume decline in Europe again this quarter with the cigarette market size in the region expected to continue its declining trend. We also expect weaker growth in Asia relative to the previous quarter, primarily due to tobacco packaging laws introduced in Australia. Overall, we expect revenues to either remain flat or show a slight decline relative to the same quarter last year due to a net decline in volumes, although this may be offset by price increases.

Europe to Continue Declining Trend

The company, and the tobacco industry as a whole, faces a multitude of problems in the EU. First, weak macroeconomic conditions have changed customer spending habits in the region with a large number of smokers switching to discount brands. This has hurt the mix of revenues and the margins realized on cigarette sales in the region. We expect this trend to impact this quarter’s results as well.

Second, persistent tax increases have forced cigarette manufacturers to increase prices on their products, which has led to either smokers quitting or switching to alternatives such as rolling tobacco, smokeless tobacco products or, in many cases, to illicit cigarettes. In fact, the illicit cigarette industry in Europe has been booming in the past few years with a 2011 report by KPMG estimating that the industry has 10% share of all cigarettes sold in the EU.

Australia’s Tobacco Packaging Laws to Affect Sales

Australia is at the forefront of the war against the tobacco industry. Earlier this year, the country’s highest court upheld a law despite heavy opposition from the tobacco industry, which forces all cigarette companies in the region to sell their products in standardized olive-green packs with large graphic warning labels.

The law, in-line with recommendations from the World Health Organization (WHO), indicates that cigarette companies cannot display their brand names and distinctive designs on their packs. This is expected to result in a steep long-term decline in the number of first time smokers and may also cause a decline in the existing number of smokers.

We account for cigarette sales in Australia within the Asia division. We believe the impact of this law will result in a long-term decline in the cigarette market size in the region, and there is a possibility that the impact may have been felt this quarter itself. We estimate the cigarette market for Asia at 1.1 trillion units currently, and expect it to increase marginally over the course of our forecast period to reach close to 1.2 trillion units.

We currently have a Trefis price estimate of $89 for Philip Morris, which is around 5% below the market price.

Understand How a Company’s Products Impact its Stock Price at Trefis