Can iQOS Continue Its Tremendous Momentum For Philip Morris In Its Fourth Quarter?

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Philip Morris

Philip Morris International (NYSE:PM) is scheduled to report its fourth quarter and full year ended December 2016 earnings on February 2, 2016, before the markets open. Declining volumes in the industry seem to be the norm, and Philip Morris is no exception to this trend. Given the change in consumer preferences, the company has slated to focus more on its reduced risk products (RRPs). Besides this, currency headwinds are also expected to weigh down on the company’s earnings. According to the company’s estimates, this factor will negatively impact the earnings by $0.35 per share for the year.

Screen Shot 2017-02-01 at 6.36.51 pm PM Pre Earnings Q4 2016

See Our Complete Analysis For Philip Morris International

Key Trends Expected In The Quarter:

  • Lower Cigarette Volumes

A majority of the advanced economies are experiencing a decline in the smoking rates, and consequently the tobacco companies’ cigarette volumes have been facing a downward trend for the past few quarters. This has been a consequence of the numerous tax hikes, ban on tobacco marketing and smoking in public places, and growing awareness among the consumers. This trend is expected to continue in the fourth quarter as well. In order to cope with this, the company is focusing more on its less harmful tobacco products, in order to ensure growth in the future. On January 25, the company also reaffirmed its commitment to designing a smoke-free future. PM has hired over 400 scientists and experts, along with an investment of more than $3 billion in research, product development, and scientific substantiation for this purpose.

Global Cigarette Volumes

  • Currency Headwinds

As the company is US based, but derives all its revenues from international sales, it is highly exposed to the strength of the Dollar. The company’s third quarter results had been encouraging, particularly since the unfavorable impact of the Dollar was far smaller than it had been in earlier quarters. However, the resurgence in the value of the Dollar in recent months may be troubling news for the company. Since the beginning of October, the Dollar Index has risen by more than 5%, with the Euro losing almost 5% of its value against the Dollar, and the Japanese Yen declining by an even larger amount of 12%. These factors may result in a substantial hit to the earnings of the company.

Dollar Index Spot

  • Momentum Of iQOS

iQOS has witnessed phenomenal growth in Japan, since it was first launched, with its  market share steadily climbing. During FY 2015, the iQOS launch was expanded in Japan to reach 60% of the adult smoking population, and the national roll-out was completed in the beginning of the second quarter of FY 2016. For the third quarter, the HeatSticks market share increased to 3.5%, an increase of 1.3 points, compared to the second quarter. Furthermore, the share in the last week of September reached an estimated 4.3%, and an even higher 7.3% in Tokyo, despite limited expansion due to supply constraints. According to the latest data supplied by the company, the weekly market share increased to 4.9% in October. Moreover, the level of cannibalization has also come down, from 40% seen earlier, to 35% in the second quarter.

iQOS Growth

Given the strong growth seen by the product, Philip Morris, with Altria, has also filed a Modified Risk Tobacco Product Application (MRTPA) for iQOS with the US FDA. According to Reuters, Philip Morris is the first company to seek US approval to market a tobacco product as being less harmful than traditional cigarettes since the new laws were introduced. Once the MRTP claim is approved by the FDA, the company will hold a significant marketing advantage over other reduced risk tobacco products, including ecigarettes, which are not allowed to make such a claim. They can, however, request approval from the FDA for this status as well, so long as they are less harmful. The company believes that since its products heats the tobacco, instead of burning it, it will be safer for consumers. IQOS is currently present in key cities in 15 markets worldwide, including Japan, Canada, Germany, Italy, and the UK, with plans to make it available in key cities in over 30 countries by the end of 2017.

  • Margin Expansion

According to Wall Street expectations, Philip Morris is estimated to post a gross margin, EBIT (earnings before interest and tax) margin, and net margin of 63%, 40.7%, and 26%, respectively. For the fourth quarter in the prior year the margins were 62.8%, 30.8%, and 19.6%, respectively, which represents year-on-year growth of 0.2%, 9.9%, and 6.4%, respectively. This expansion is expected to occur due to higher cigarette prices, increased sales of reduced-risk products, which have higher margins, as well as reduction in SG&A expenditure. In the fourth quarter of FY 2015, the expenses trended higher due to the implementation of European tobacco products directive. Since this is already under implementation, the expenses for this quarter should be lower.

PM Margins

Have more questions on Philip Morris? See the links below:

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Notes:

1) The purpose of these analyses is to help readers focus on a few important things. We hope such lean communication sparks thinking, and encourages readers to comment and ask questions on the comment section, or email content@trefis.com

2) Figures mentioned are approximate values to help our readers remember the key concepts more

intuitively. For precise figures, please refer to our complete analysis for Philip Morris International.
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