Philip Morris Q3 FY15 Earnings Review: Business Fundamentals Strong Even As Short-Term Headwinds Persist

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Tobacco conglomerate, Philip Morris International (NYSE:PM), reported fiscal third quarter earnings on October 15. Although currency headwinds continued to be a drag on results, Philip Morris showed strong fundamentals on the business side of things. Just like the first two quarters, Q3 continued to show strength, with revenues expanding 5.9% on a currency neutral basis, to beat analyst estimates. This was underpinned by strong pricing and share gains in key markets, even as industry volumes continued to decline. Here is an analysis of the key takeaways from the company’s Q3 results and what we can expect going forward.

A Walk Through Key Markets 

Let’s start by looking at the company’s performance in key markets.

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European Union (EU): Philip Morris witnessed strong performance in the region, with revenues and operating companies income (OCI) growing 4.5% and 5.9%, respectively, on a currency neutral basis. These numbers were achieved through strong pricing, combined with moderation in industry declines, against an improvement in the macroeconomic environment, reduction in illicit proliferation, and a slowdown in e-cigarette use.

— Eastern Europe, Middle East and Africa (EEMA): EEMA also presented strong results on a currency neutral basis, with net revenues increasing 9% and OCI increasing 12.3%. This was guided by strong pricing in Russia, Turkey, and Ukraine, along with a 2.6% increase in shipment volumes guided by Egypt, Russia, Saudi Arabia, and Turkey.

 Asia: While EU and EEMA posted strong results, Asia showed some slack in Q3, with revenues growing just 0.9% on a currency neutral basis. This was because shipment volumes declined in key markets such as Indonesia and Japan, where the total market size declined. This was partially offset by stronger pricing in markets such as Australia and Indonesia. 

 Latin America and Canada: Latin America also presented strong results, with revenues and OCI increasing 13.9% and 29.6%, respectively, in the quarter on a currency neutral basis. This performance was guided by strong pricing, notably in Argentina, Brazil, Canada, Ecuador, and Mexico. Although industry volumes continued to display a declining trend in the quarter, key brands such as Marlboro, saw share gains in the region, which helped Philip Morris hold up its performance.

Clearly, the currency neutral numbers reported suggest that Philip Morris’ business fundamentals are in place. This is further confirmed when one looks at the performance of key brands such as Marlboro, L&M, and Philip Morris, shipment volumes for which increased by 2.1%, 9.3%, and 17.9%, respectively, in the quarter. 

What Could Work Going Into Q4?

Fundamentally, Philip Morris’ success in the first three quarters of the fiscal year can be attributed to solid pricing strategies. These strategies have not only helped in mitigating losses coming in from industry declines, but have also been instrumental in Philip Morris garnering share gains. For instance, in some markets, Philip Morris resorted to price hikes in brands at lower price points, which resulted in customers trading up to more premium options such as Marlboro, to increase overall revenues. We anticipate such strategies to continue to steer the company through Q4 as well. 

Apart from pricing, Philip Morris has also resorted to innovations, particularly in the Reduced Risk Product (RRP) space. At a time when traditional cigarette volumes continue to decline, innovations in RRP could benefit the company in Q4 and there after. The most recent innovation in this space include the iQOS, a type of smokeless cigarette, which was launched in cities across Switzerland, Italy, and Japan. Apart from extending the product to different markets, Philip Morris is also investing in it to improve its features and functionality. Based on the research conducted on the Japanese market, Philip Morris has reported satisfactory results for the product. Although product satisfaction initially showed a decline, it quickly recovered in Japan to meet the grade secured by cigarettes. In this situation, the RRP portfolio, and iQOS in particular, could be one powerful way for Philip Morris to secure revenues going forward. 

A Note On Risks

Finally, let’s move on to risk factors. Based on Philip Morris’ stellar performance in the first three quarters of the year, the company has revised its guidance figures forecasting EPS to fall in the $4.35 to $4.40 range. This is a 11-12% increase, in comparison to the 9-11% increase anticipated earlier. However, the company has also revised its forecasts for the negative impact of currency headwinds, which is now being anticipated at $1.22 per share. 

Currency headwinds could continue into Q4 as the dollar could continue to maintain or even increase its strength. Ever since the Federal Reserve announced the Quantitative Easing (QE) taper, investors have diverted funds towards the dollar in anticipation of rate hikes, which has resulted in increasing its strength in comparison to other currencies. Since Philip Morris functions in diverse geographies, a strengthening dollar could translate into fewer dollars in exchange for the local currency, which would hurt the company’s financials. Recently, the Fed once again resisted an interest rate hike, which could continue to divert capital to the dollar to further increase it’s strength. Currency headwinds in Q3 impacted Philip Morris’ revenues by $3.6 billion and this trend could very well continue going into Q4.

However, pressures on the cost front and that on the currency front may not be reason enough to write off Philip Morris. The company has continued to display strong growth in dividends and revenues on a currency neutral basis. Furthermore, the costs incurred in relation to iQOS or any new innovations could only go on to generate higher return in the future, which could actually put the company in a better position going forward. Hence, Philip Morris’ performance in Q3 tells us that the company’s business fundamentals continue to remain strong, although headwinds could continue to impact financials in the short-run.

We have a price estimate for Philip Morris’ stock price of around $81, which is lower than the current market price. We will be updating our price estimate in light of the recent earnings release.

See Our Complete Analysis For Philip Morris International

Key Financial Metrics At A Glance – Q3 Results

  • Reported net revenues declined 11.8%. Excluding currency impact, net revenues increased 5.9%.
  • Reported OCI declined 12.3%. Excluding currency impact, OCI increased 9.3%.
  • Reported diluted EPS at $1.25, declined 9.4%. Excluding currency impact, diluted EPS increased 15.8%.

Sources:

  1. Philip Morris International’s (PM) Management on Q3 2015 Results – Earnings Call Transcript
  2. PHILIP MORRIS INTERNATIONAL INC. (PMI) REPORTS 2015 THIRD-QUARTER RESULTS

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