Philip Morris Q3 Earnings Likely To Be Along Expected Lines

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Philip Morris (NYSE: PM) is set to report its 2014 third quarter earnings on October 16. We expect the management’s expectations of reduced earnings to materialize on account of factors identified in the second quarter earnings report and reported in this article. Philip Morris’ earnings per share increased from $1.19 in Q1 to $1.41 in Q2 this year. Analyst’s consensus estimate at Bloomberg Businessweek suggests this could go down to $1.36 in Q3 and $1.2 in Q4. [1] Trefis has a $79 price estimate on Philip Morris’ stock compared to a market price of around $84.

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Why Are Earnings Expected To Go Down?

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Earnings are likely to go down this quarter on account of three sources of costs that became important this quarter. The first of these are the investments that are to be made towards the commercialization of reduced risk products. The second of these costs relates to the roll-out of Marlboro Red 2.0. The final source of increased costs is the expenses to be incurred in completing the shutdown of its factory in the Netherlands as part of optimizing its manufacturing infrastructure. [2]

As part of the commercialization of its reduced risk products, Philip Morris has opened a pilot plant for the manufacture of such products. A large scale manufacturing facility for such products is still under construction. Together they are expected to cost €500 million in investment. The construction of the pilot plant was completed in less than a year.  It is now fully operational. It is aimed at facilitating initial market launches and test studies. [3]

Another source of expenses this quarter is the development of the new brand architecture around Marlboro. Marlboro Red brand had received significant investment in redefining the brand in earlier quarters. It now features new pack and filter designs. The commercial deployment of this new brand is likely to have a negative impact on earnings by jacking up costs incurred in the quarter. [2]

Philip Morris also shut down its manufacturing facility in the Netherlands, which was its largest production facility word-wide. 90% of the workforce there has been laid off and production has been shifted to other factories in Europe with spare capacity. This development in response to declining domestic demand will affect earnings through increased costs related to shutdown, worker lay-off costs and logistics involved in shifting production. [4]

Global Factors Affecting Earnings

One of the major challenges to healthy earnings that Philip Morris will face this quarter is the steady strengthening of the U.S. dollar versus other currencies, especially of Europe. The dollar index, which measures the strength of the dollar against other major international currencies, saw dollar strengthen by ~7.5% this quarter as its value went from 80 in July to over 86 in September. [5] Since Philip Morris earns significant income in these international currencies, its earnings suffer when they decline against the dollar. The silver lining for Philip Morris here is that Asian currencies have strengthened by about 1.7% against the dollar in September. [6] This means its revenue gains in Asia translates to a greater gain in dollar terms when it reports its earnings.

Another global factor that can  affect Morris’ earnings is the impact of plain packaging legislation. The Australian government had claimed that its tobacco plain packaging rules had helped reduce smoking in Australia significantly. (See Philip Morris In Australia) While Australia is not a big source of revenues for Philip Morris, if these results are replicated in other geographies that have seen such regulations, earnings could be affected negatively. For instance, Indonesia, which is a major market for PMI products, has seen such a regulation come into force in September. (See Philip Morris In Indonesia) Philip Morris has even hinted at suing the Uruguayan Government over infringement of its trademarks through a similar law. (See Uruguayan Lawsuit For Philip Morris) While its still early for the full impact of most of these laws to be felt, we may get a preview of it in this quarter”s earnings.

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Notes:
  1. Philip Morris International, businessweek.com []
  2. Q2 Earnings Call Transcript, seekingalpha.com [] []
  3. PMI Opens Pilot Plant, yahoo.com []
  4. Philip Morris To End Production In Netherlands, wsj.com []
  5. Bloomberg Dollar Index Spot Quote []
  6. Bloomberg Asia Dollar Index []