Philip Morris International (NYSE:PM) has had a tough 2013. The company’s stock price has remained relatively flat year-to-date while the S&P 500 has gained more than 20%. It has been hurt the most by lower shipment volume due to macroeconomic headwinds in the EU and anti-tobacco legislation in the key markets of Philippines and Russia. Currency headwinds due to stronger U.S. Dollar have also weighed on the company’s earnings growth. In this article, we review the key industry trends that impacted Philip Morris International this year.
Philip Morris International is a leading international tobacco company with its products sold in more than 180 countries worldwide. Until its spin-off in March 2008, Philip Morris International was an operating company of Altria Group (NYSE:MO). Excluding the U.S. and China, the company holds more than 28% of the total international cigarette market, led by its flagship brand Marlboro.
We currently have $95 price estimate for Philip Morris International, which is almost 10% above its current market price.
Volumes In The European Union To Continue To Decline
Philip Morris’ EU operations have been under pressure over the past few years due to the growing presence of illegally traded cigarettes in the region amid weak macroeconomic conditions and a difficult regulatory environment for tobacco products. Illegal trade of cigarettes is a huge concern for the local governments as well as cigarette manufacturers in the EU. Its growing prevalence has been exaggerating the decline in tax-paid cigarette consumption in the region. The tax-paid cigarette market has declined by ~20% in volume over the past five years while overall cigarette consumption in the EU has declined by ~17%. This is primarily because the volume of illegally traded cigarettes grew by 8% to 65 billion units over the same period.
We estimate the number of illegally traded cigarettes consumed in the EU in a given year as a difference between the total number cigarettes of consumed in the region and the size of tax-paid cigarettes market. First, we derive the size of the tax-paid cigarettes market using market share and shipment volume data provided by the company. Then, we use the percentage share of illicit trade as estimated by the European Commission to calculate the total number of cigarettes consumed in the EU. 
More importantly, the trend has worsened over the recent years due to excise tax hikes and high unemployment rates that are driving consumers towards cheaper cigarettes. As a result, cigarette manufacturers have been reporting sharp declines in shipment volumes. Philip Morris’ shipment volume in the EU dipped by ~7% y-o-y for the first nine months of this year despite being able to maintain its market leadership in the region. 
Many consumers in the EU have also been shifting to lower priced other tobacco products (OTP) of late. In most countries, excise taxes on tobacco products other than cigarettes (cigars, cigarillos, fine-cut tobacco for hand-rolling cigarettes, pipe tobacco, snus, chewing tobacco and so on) are subject to much lower excise tax levels compared to manufactured cigarettes, which makes them relatively cheaper. 
The New Anti-Tobacco Law In Russia Weighs On Volumes
Russia, where 40% of the population smokes, is the second largest market for cigarettes in the world by consumption volume. The market has been one of the key growth engines for Philip Morris International over the past few years. In 2012, Russia contributed around 30% of total cigarettes shipped by the company in the Eastern Europe, Middle East and Africa (EEMA) region. 
However, its shipment volumes in Russia declined more than 10% during the third quarter as a result of the implementation of excise tax hikes and other anti-tobacco measures. Specific excise tax on cigarettes increased more than 40% y-o-y in 2013. Apart from this, the Russian anti-tobacco bill that was signed into law on February 25, 2013, also came into effect on June 1. It initially banned smoking at schools and universities, museums, sports facilities, hospitals and on public transport, but would be extended to cafes, restaurants and hotels next year. It also includes provisions for implementing a minimum price on cigarettes starting next year and banning tobacco sales at street kiosks. The law primarily aims at lowering annual smoking-related casualties in Russia by half over the next decade by restricting the marketing and sale of cigarettes and smoking in public areas. According to the World Health Organization (WHO), a ban on public smoking is the second most effective tool for reducing smoking prevalence in any region after indirect taxes. 
Disruptive Tax-Hike In Philippines Drags Down Volumes
More than 40% of the total volume decline reported by Philip Morris for the first nine months of this year can be attributed to the Philippines where a sharp hike in indirect taxes implemented earlier this year disrupted an otherwise flourishing tobacco industry. Following the tax hike, the company increased prices of its Marlboro and Fortune brands by around 60% and 70%, respectively. As a result, Philip Morris recorded more than a 20% decline in cigarette shipments to the market during the third quarter. The company expects its full year volume in the Philippines to decline by 20-25%, in line with our estimates. The Philippines is one of the key markets for Philip Morris as it contributed 22% to the company’s shipments to Asia last year. 
Strengthening U.S. Dollar Drags Down Earnings Growth
Philip Morris sells cigarettes in more than 180 countries internationally. Since the company operates primarily in local currency in these markets, the strengthening U.S. dollar negatively impacts its financial results. U.S. Dollar strengthened against many international currencies in 2013, especially the emerging market currencies, amid talks of the U.S. Federal Reserve scaling back its bond-buying program.  Strong currency headwinds dragged down Philip Morris’ reported EPS by $0.23 or 5.8% during the first nine months of the year. The company also lowered its full year diluted EPS target range to $5.37-$5.42 against $5.17 last year as it expects the full year negative impact of a stronger U.S. dollar to be at $0.31 per share.  It should be noted that depreciation of a local currency against the U.S. dollar might also lead to higher relative prices of Philip Morris’ brands in the local market, thereby weakening its competitive positioning as well.Notes:
- Stepping up the fight against cigarette smuggling and other forms of illicit trade in tobacco products – A comprehensive EU Strategy, European Commission, June 6, 2013 [↩]
- Philip Morris International SEC Filings, sec.gov [↩] [↩] [↩]
- Other Tobacco Products, pmi.com [↩]
- 2013 Morgan Stanley Global Consumer Conference November 20, 2013, pmi.com [↩] [↩]
- Let the post-taper forex trading begin!, cnbc.com [↩]