Lower Volumes, Higher Taxes And Stronger U.S. Dollar To Weigh On Philip Morris International’s Second Quarter Earnings

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Philip Morris International (NYSE:PM) is set to report its 2014 second quarter earnings on July 17. We expect continued sales volume pressure, currency headwinds, and other charges to weigh on the company’s results. We believe that Philip Morris International’s second quarter sales volume would be lower year-on-year, primarily due to higher excise taxes in Russia and Japan, which are two of the company’s largest markets, and continued macroeconomic weakness in the European Union. We also expect a stronger U.S. Dollar and one-time charges related to the discontinuation of cigarette production in the Netherlands to impact its net income negatively.

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 a $79/share price estimate for Philip Morris International, which is ~15.2x our 2014 full-year diluted EPS estimate of $5.20 for the company.

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Easing Macroeconomic Pressures In The EU

Philip Morris International’s cigarette sales volume has declined at more than 1.7% CAGR between 2008 and 2013. Most of this decline has come from the European Union, where increasing excise taxes, high unemployment rates due to weak macroeconomic conditions, and high prevalence of illegally traded cigarettes has weighed significantly on the tobacco industry. Last year, the company’s sales volume in the EU declined by 7.5% y-o-y, compared to just 2-3% decline in Asia and Eastern Europe, the Middle East and Africa (EEMA) regions. [1]

However, Philip Morris International expects improving macroeconomic indicators such as unemployment rate, consumer confidence and real GDP growth to decelerate the decline in cigarette sales in the EU going forward. According to the company’s estimates, unemployment rate in the EU averaged around 10.5% in the first 5 months of this year, compared to 10.9% at the end of last year. During a recent investor presentation, Philip Morris International stated that its cigarette sales volume in the EU declined by just 4.4% y-o-y through May this year. We expect the company’s full-year sales volume in the EU to decline by around 4% y-o-y. [2]

Regulatory Headwinds In Other Key Markets

We believe that apart from EU, Philip Morris International’s second quarter sales volume would also be lower in the key markets of Russia and Japan. In Japan, a sharp 300 basis points hike in sales tax implemented on April 1, 2014  is expected to weigh on cigarette sales this year. [3] On the other hand, in Russia, the company’s largest market in the EEMA region, tighter anti-tobacco regulations and sharp increases in indirect taxes on cigarettes are expected to continue to drag down tobacco sales. 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.

Currency Headwinds And One-Time Charges

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 impacts its financial results negatively. 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 strengthened by around 15%, 10% and 5% y-o-y during the second quarter 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% in the first quarter. During a recent presentation, the company also guided for its 2014 full-year diluted EPS to be 5.5-7.5% 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. In addition, Philip Morris International also expects to take a pre-tax charge of approximately $495 million or $0.24 per share this year due to the recent shut down of a manufacturing facility in the Netherlands in response to declining cigarettes demand in the EU. The company expects to record a majority of this charge during the second quarter. [2]

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Notes:
  1. Phillip Morris International 2013 10-K Filing, sec.gov []
  2. Philip Morris International 2014 Investor Day, pmi.com [] []
  3. Japan Raises Sales Tax For First Time In 17 Years, bbc.com []