Philip Morris Revised To $79 On Unfavorable Currency, Regulatory Headwinds

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Philip Morris

Philip Morris International’s (NYSE:PM) first quarter earnings declined due to unfavorable foreign currency fluctuations and lower sales volume. The company sold 196 billion cigarettes during the quarter, down 4.4% year-on-year. Its diluted earnings per share (EPS) adjusted for one-time items declined by $0.10 or 7.8% y-o-y. For the full year, Philip Morris International expects unfavorable currency and regulatory headwinds to lead to a 1.3-3.2% decline in diluted EPS.

Based on the recent earnings announcement, we have revised our price estimate for Philip Morris International to $79/share, which is ~15.2x our 2014 full-year diluted EPS estimate of $5.20 for the company.

See Our Complete Analysis For Philip Morris International

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Unfavorable Currency

Philip Morris International sells cigarettes in more than 180 countries. Since the company operates primarily in local currency in these markets, a strengthening U.S. Dollar negatively impacts its financial results. The U.S. Dollar has strengthened significantly against many international currencies, especially the emerging market currencies, since the second half of 2013 when the U.S. Federal Reserve started scaling back its bond-buying program. According to historical currency charts provided by xe.com, the U.S. Dollar has strengthened by 20%, 15% and 12% y-o-y against Indonesian Rupiah (IDR), Russian Ruble (RUB) and Brazilian Real (BRL), respectively.

Strong currency headwinds dragged down Philip Morris International’s adjusted diluted EPS by $0.16 or ~12% during the first quarter. The company also guided for its 2014 full-year diluted EPS to be 1.3-3.2% lower, compared to last year, as it expects the strengthening U.S. dollar to drag down its full-year earnings by $0.61 per share. It should also be noted that the depreciation of a local currency against the U.S. dollar might also lead to higher relative prices of Philip Morris International’s brands in the local market, thereby weakening its competitive positioning as well.

Regulatory Headwinds

Regulatory headwinds continue to worsen operating conditions for Philip Morris International. The company sold 4.4% fewer cigarettes during the first quarter. Most of the decline in sales volume came from the European Union (EU) and Russia. In the EU, cigarette manufacturers continue to battle the growing prevalence of illegally traded cigarettes and excise tax hikes amid weak macroeconomic conditions. Because of these factors, Philip Morris International’s sales volume declined by 10.6% and 8.9% in Poland and France respectively. The company’s cigarette shipments to Germany and Spain also declined by 3% and 3.6% y-o-y. We expect its sales volume in the EU to continue to remain under pressure for the rest of the year, as we do not see the underlying trends easing in the short term. (See: Philip Morris’ Potential Downside From The EU’s Illegal Cigarette Trade)

Operating conditions in Russia, Philip Morris International’s largest market in the Eastern Europe, the Middle East and Africa (EEMA) region, have also been deteriorating because of sharp hikes in indirect taxes and tighter anti-tobacco regulations. During the first quarter, the company’s sales volume in the country declined by almost 9% y-o-y as a result of the implementation of excise tax hikes in June last year and January this year. Apart from this, a new anti-tobacco bill that was signed into law on February 25, 2013, also came into effect on June 1, 2013.

The new anti-tobacco law aims to reduce 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. It initially banned smoking at schools and universities, museums, sports facilities, hospitals and on public transport, but bans will be extended to cafes, restaurants and hotels this year. It also includes provisions for implementing a minimum price on cigarettes starting this year and banning tobacco sales at street kiosks. Therefore, the business environment in Russia is expected to continue to remain harsh for Philip Morris International for the rest of the year as well.

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