Philip Morris Earnings: Currency Impact, Regional Challenges Weigh On Results

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Philip Morris International’s (NYSE:PM) fourth quarter and full year 2014 earnings gave an indication of the company’s uncertain situation. Currency fluctuations took a large chunk out of the revenues, and there was significant variance in the top line performance across and within regions. However, in most regions, the common themes were declining market sizes, modest market share gains and price hikes. The revenue increase achieved through these price hikes was undone by certain one time expenses that weighed on profits.

We have a price estimate for Philip Morris of around $80, slightly lower than the market price.

See Our Complete Analysis For Philip Morris International

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Europe: Costs Outpaced Revenue

In our pre-earnings report, we considered many of the fundamental factors in Philip Morris’ largest markets. Europe is the largest contributor to Philip Morris’ top line, and the company managed to grow these revenues by 2.8% in 2014. This was primarily due to favorable currency impacts and pricing gains. These factors helped make up for the 3.1% decline in 2014 in the E.U. cigarette market size. The revenue was also aided by a market share increase of one percentage point in the region. [1]

However, the region was also subject to a significant one time expense, in the form of the closure of Philip Morris’ largest plant in the world. The exit costs of shutting down the plant in the Netherlands amounted to $500 million. About 72% of these expenses were due to employee separation costs, with the remainder due to the asset impairment reflecting the write-down of plant and machinery. Excluding the favorable currency impacts, the operating income for the region dropped by nearly 13%, partly due to this expense. [1]

EEMA: Currencies Eat Into Pricing Gains

Philip Morris was able to enhance its pricing power in Eastern Europe And Saudi Arabia as well. This helped it increase its revenues, excluding the currency impact, by 10.5% year on year in 2014 in Eastern Europe, Middle East and Asia (EEMA). However, Eastern Europe claimed much of this revenue increase through weak currencies and the unfavorable volume mix. The Russian Ruble was the worst performing currency as far as Philip Morris was concerned, accounting for 42% of the company’s global unfavorable currency variance. [2] The cigarette market in the country decreased by approximately 9.2% in 2014, and is forecast to decline by another 8-10% in 2015. The main culprits behind this reduction are the excise tax increases and the worsening economic situation (See Our Earlier Article On Philip Morris In Russia). [1]

A factor that may have helped drive revenue growth is the company’s investment in its distribution system. Philip Morris bought a 20% stake in Megapolis, which has a near monopoly in cigarette distribution in Russia. This may have reduced the distributor margins and enhanced the company’s top line. [2]

Asia: Growth Engine Slowing Down?

Asia is the largest contributor to our valuation of Philip Morris’ stock at 37% of the stock price. This is due to the projected growth in the number of cigarettes sold in the continent. Philip Morris’ revenue from Asia, however, decreased by 7.2% in 2014, excluding unfavorable currency impacts. Once these are incorporated, the reduction in revenue becomes around 17%. The four countries that adversely impacted Philip Morris’ results in the continent were Japan, Australia, Indonesia and the Philippines. [1]

In Japan, retail price increases in response to a tax hike led to a 3.4% reduction in the market size in 2014. This is expected to continue into 2015, with a forecast of a 2.5-3% market size reduction in 2015. However, contrary to other markets, the market size reduction here led to a decline in market share for Philip Morris of 0.9 percentage points. Indonesia’s cigarette market continued to grow with a nearly 2% increase in 2014 (See Our Earlier Article on Philip Morris In Indonesia). However, Philip Morris could not take advantage of the shift in consumer preference towards machine made cigarettes. Its reliance on hand rolled cigarettes saw it lose 1.3 percentage points of its market share. [1]

In the Philippines, non-duty paid cigarettes remain the major challenge for Philip Morris. In its Q3 earnings call, the company claimed that its rival, the Mighty Corporation, is reporting less than half of its actual sales. This is leading to a decline in tax-paid  cigarette sales, while consumer surveys show resilience in the consumption of cigarettes. Despite increasing its market share of the tax-paid cigarette market by 3 percentage points in 2014, the company saw a decline in its volume of cigarettes shipped. This is because the tax-paid cigarette market itself shrunk by 4.6% last year, allegedly due to the rise in the number of illicit cigarettes. [1]

Latin America’s Currency Woes

Latin America saw a revenue increase of 10.6% in 2014, which turns into a revenue reduction of 2.3% once currency impacts are factored in. For the full year, the operating income increased by 12.3% excluding currency impacts, though it decreased marginally in Q4 2014. Higher marketing costs in Mexico related to the roll-out of the Marlboro 2 brand architecture contributed to this decline. [1]

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Notes:
  1. Philip Morris International 2014 Results [] [] [] [] [] [] []
  2. Philip Morris Q4 2014 Earnings Analysts Call [] []