Philip Morris Earnings Preview: Cigarette Volume Decline Moderates, Foreign Currency Headwinds Persist

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Philip Morris International’s (NYSE:PM) fourth quarter and full year results will be announced before the market opens on February 4, 2016. The consensus estimate for the adjusted diluted earnings per share in the fourth quarter is $0.81, representing a 23.6% fall compared to an EPS of $1.06 in Q4 2014. [1] However, the adverse impact of foreign currencies is primarily responsible for this decline, as was the case in the third quarter. The company has increased retail prices in key markets, such as Argentina, Indonesia, Philippines, and Russia, which will help offset the decline in revenues caused by a fall in cigarette volumes and incremental investments for iQOS, its heat-controlled tobacco sticks.

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Foreign Currency Headwinds To Reduce In 2016

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Organic cigarette volume declined a modest 1.5% in the third quarter, mirroring the industry trend, partially offset by market share gains in the Eastern Europe, Middle East, and African Region (EEMA) and the Latin America and Canada Region (LA&C). [2] For 2015, the company forecasts an organic cigarette volume decline of 1%-1.5%, and a 2.5% decline when China and the U.S. are excluded. A lower level of decline reflects improving macroeconomic conditions, as well as a moderation in the level of illicit trade.

International Cigarette Volume Decline

Unfavorable foreign currency effects are estimated to have had an impact of $1.22 per share for the full year. While currency is again expected to affect the results in 2016, the extent is to be much lesser – 27 cents per share. As Philip Morris operates exclusively outside the U.S., interest rates are significant, as they have a major impact on the U.S. dollar. Following December’s rate hike, the Federal Reserve is now expected to keep the interest rates pegged back due to the uncertainty in China and the global economy. This would, in turn, weaken the dollar and thus improve the earnings of the company.

FX effect

Banking On Reduced Risk Products

According to PM, experts agree that nicotine, while addictive, isn’t the primary cause of smoking-related diseases; it is, in fact, the toxic compounds in cigarette smoke, formed when the tobacco is burned. Consequently, Philip Morris has undertaken substantial investment and started developing less harmful alternatives to cigarettes, which can be a major benefit to public health. Their current reduced risk products (RRPs) portfolio includes four product types- two that use different innovations to heat, rather than burn tobacco, and two e-vapor items that do not contain any tobacco. [3] The firm’s aim is to garner 10%-15% of its sales from its RRPs portfolio within a decade. The company is betting on one such product, iQOS- a black pen-shaped device that heats sticks containing tobacco, and feels it will become more popular than e-cigarettes sold by other companies. Based on favorable tests in Italy and Japan, the company decided to accelerate its rollout in 2015, to more geographies than initially planned. [4] In November, the product was expanded to cities like Moscow, Lisbon, and Bucharest, in addition to continued activity in Switzerland, and further expansion in Italy and Japan. [5] IQOS has been the result of ten years of research and an investment of about $2 billion. [6] Hence, the company has a lot riding on this; especially since its traditional tobacco product sales in developed countries have been on the decline. Continued public health campaigns, increasing taxes on tobacco products, and marketing restrictions have made growth in this sector particularly hard. Tobacco companies, such as Philip Morris, are also increasingly relying on developed countries for growth in its tobacco products line, as smoking rates there are still rising.

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Notes:
  1. PM Earnings Date, Nasdaq []
  2. PMI Q3, 2015- Earnings Presentation []
  3. PMI- Reduced-Risk Product Development []
  4. PMI Q3, 2015- Earnings Call Transcript []
  5. PMI Presentation at Morgan Stanley Global Consumer & Retail Conference, New York, November 2015 []
  6. New Era Begins in Japan []