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Investment Overview for Philip Morris International (NYSE:PM)
- Price hikes in a number of markets to combat declining volumes
- The tobacco industry, in general, is a declining one, where volume declines have been a regular feature. Cigarette shipment volumes were down 4.4% in the fourth quarter of 2016. In order to combat the declining volumes against increasing regulatory control, excise tax hikes, and increasing health consciousness among people, Philip Morris raised prices in a majority of its key markets.
- Innovations could drive volumes and ensure share gains
- Philip Morris has seen soft cigarette volume trends for the past few quarters, due to a general shift away from tobacco products, amid accelerating prices of cigarettes and worldwide anti-tobacco campaigns.
- Keeping this in mind, the company has undertaken significant investment to expand its reduced risk products (RRPs) range, in particular iQOS -- a black pen-shaped device that heats a Marlboro-brand ‘heatstick’ containing tobacco, instead of burning it.
- Strong performance of the company's reduced risk portfolio (RRPs), notably HeatSticks and iQOS devices, helped push the company’s growth. Approximately 22% of the RRP net revenue of $733 million in 2016 was attained from iQOS devices, which, however, yielded a negative margin due to introductory discounts offered in the initial commercialization phase to accelerate adult smoker switching. The HeatSticks volume reached 7.4 billion units in the year, which reflected the maximum manufacturing capacity of the company. The volume would have trended even higher without the capacity restrictions, which forced the company to limit the iQOS device sales in Japan since June.
- Japan is the only country where the national roll-out of iQOS has occurred, and it has witnessed exceptional performance. The market share has steadily climbed since it was first introduced in the country. 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. The market share of HeatSticks continued to expand, and carried on its strong sequential growth, reaching 4.9% in the fourth quarter. Furthermore, in the final week of December, the national market share touched an estimated 5.5%, and its off-take (select C-store sales volume as a percent of total sales volume for cigarettes and HeatSticks) share increased to 7%. The product has been launched in a number of key cities in Europe as well.
- Globally, as well, the product has performed favorably, serving as an indicator of the future potential of iQOS. Conversion rates of iQOS purchasers, who have fully or predominantly converted to the product, have grown over time, and stood at approximately 70% at the end of 2016. As of year-end 2016, the company estimates that approximately 1.4 million adult consumers have quit cigarettes and converted to iQOS.
- In most countries where iQOS is launched, the company received a favorable tax treatment for heatsticks, as compared to cigarettes. This enabled it to price it lower than cigarettes in certain markets, such as Switzerland.
- Updates on the most recent results
- Philip Morris reported reported its fourth quarter and full year 2016 earnings on February 2, 2017. While the company missed consensus estimates on earnings per share by a penny, the metric increased almost 36% in the quarter, primarily attributable to higher sales. Excluding the negative currency impact, the earnings soared 52% year on year. Net revenue was up by 9.1%, outpacing the consensus estimates by 4.5%, driven by higher sales in Asia and the European Union. Cigarette shipment volume fell by 4.4%, stemming from a shift away from tobacco products, as well as a decline in market share. While traditional cigarettes continue to see weak demand, the company has reported impressive growth in its 'heat-not-burn' products. It shipped 3.7 billion HeatSticks, compared to 62 million in the same quarter last year.
Below are key drivers of Philip Morris International's (PMI) value that present opportunities for upside or downside to the current Trefis price estimate for Philip Morris International:
Philip Morris International Revenue per Cigarette in Europe and Asia and EEMA and Latin America & Canada - We currently estimate revenue per cigarette to annually increase by 2-4% in its various geographical segments. If however, the increase in each segment is half of our current estimate, because of higher excise duties and lower pricing, it would imply a 10-12% downside to the Trefis price estimate.
Philip Morris International is a leading international tobacco company, with a wide range of premium, mid-price, and low-price brands, comprised of international, as well as local brands. Until the spin-off in March 2008, Philip Morris International was an operating company of Altria Group. The newly independent Philip Morris International sells tobacco products in international markets, while Altria maintains its operations in the US. While U.S. sales revenues have been in decline as Altria struggles to cope with higher state tobacco tariffs and the tobacco industry's negative image in the US, international sales continue to grow for PMI.
Their portfolio of international and local brands is led by Marlboro, the world’s best-selling international cigarette, which accounted for approximately 35% of their total 2016 shipment volume. In addition to this, PMI also has six of the top fifteen brands by volume globally such as L&M, Philip Morris, Bond Street, Chesterfield, Parliament, and Lark, which are sold in more than 180 markets globally.
In addition to the manufacture and sale of cigarettes and other tobacco products, PMI is engaged in the development and commercialization of Reduced-Risk Products (“RRPs”). RRPs is the term PMI uses to refer to products with the potential to reduce individual risk and population harm in comparison to smoking cigarettes.
The four divisions of Philip Morris International consist of the following four regional segments:
- European Union
- Eastern Europe, Middle East, and Africa (EEMA)
- Latin America and Canada
Philip Morris International largely serves "discriminatory consumers," who are concerned with where the tobacco was grown and the quality of the product they are purchasing, with brands like Marlboro, L&M, Parliament, Philip Morris, and Chesterfield. The firm also maintains a portfolio of three value company brands (Bond Street, Red and White, and Next) for the "value consumers" who are more concerned with the price of tobacco products. It also owns local brands such as Dji Sam Soe, Sampoerna, and U Mild in Indonesia; Champion, Fortune, and Hope in the Philippines; Apollo-Soyuz and Optima in Russia; Morven Gold in Pakistan; Boston in Colombia, Belmont, Canadian Classics, and Number 7 in Canada; Best in Serbia; f6 in Germany; Delicados in Mexico; Assos in Greece, and Petra in the Czech Republic and Slovakia, to take advantage of established brands as opposed to marketing new brands in some regions.
Most tobacco and cigarette businesses today follow a Price-Profit First Strategy and enjoy significant room for strong net pricing and margin expansion. With declining cigarette sales, Philip Morris International's revenues and profits are maintained through higher pricing, which is a key driver of its performance.
Philip Morris International benefits from significant geographic diversification, with good exposure to emerging markets, which have high growth, and developed markets, which have higher operating margins.
Reduced Risk Products (RRPs)
The company has undertaken significant investment to expand its reduced risk products (RRPs) range, in particular iQOS -- a black pen-shaped device that heats a Marlboro-brand ‘heatstick’ containing tobacco. In the beginning of the second quarter of 2016, Philip Morris completed the national roll-out of iQOS in Japan. In Italy, the expansion was extended beyond Milan to Modena, Rome, and Turin. It was further launched in major cities across Switzerland, and city launches were started in Bucharest, Lisbon, and Moscow. Till the end of the fourth quarter of 2016, iQOS has been launched in key cities in 20 markets globally, with aims to expand nationally in many of these markets this year. The company is also targeting additional launches in 10 to 15 markets by year end, subject to capacity. Currently the company has 15 billion units of installed annual HeatSticks capacity, and expects an average of 32 billion units in total capacity to be available for commercialization this year. The company anticipates an installed annual capacity of approximately 50 billion units by year-end.
Declining tobacco consumption
Volume of tobacco products sales have been declining due to growing health consciousness among people about the extreme health risks of smoking. Governments have also been discouraging tobacco consumption through high excise duties and legislative controls such as bans on public smoking and strict restrictions on the advertising and marketing of tobacco products and compulsory health warnings.
High excise duty on tobacco products as well as proposed anti-tobacco legislations
Tax regimes, including excise taxes, sales taxes, and import duties, can disproportionately affect the retail price of cigarettes versus other tobacco products, or disproportionately affect the relative retail price of their cigarette brands versus cigarette brands manufactured by certain competitors. Because their portfolio is weighted toward the premium-price cigarette category, tax regimes based on sales price can place the company at a competitive disadvantage in some markets. State and local governments tax tobacco products for both revenue and public health purposes. Such excise taxes are at times as high as 30-80% of revenues for cigarettes in different countries. Regular excise tax increases or unfavorable changes in the tax structure lead to increases in cigarette prices and a fall in demand.
Governments also resort to anti-tobacco legislation and anti-smoking laws to discourage tobacco and cigarette consumption. Legislation, like that banning smoking in public places, lead to a reduction in cigarette sales. Proposed bills for disclosure in different countries and those mandating plain (generic) packaging for tobacco products (like Tobacco Plain Packaging Bill, 2011 in Australia) result in the expropriation of tobacco companies trademarks.
Significant regulatory developments will take place over the next few years in most of the markets, driven principally by the World Health Organization's Framework Convention on Tobacco Control (“FCTC”). The FCTC is the first international public health treaty on tobacco, and its objective is to establish a global agenda for tobacco regulation. The FCTC has led to increased efforts by tobacco control advocates and public health organizations to reduce the palatability and attractiveness of tobacco products to adult smokers.
Philip Morris' share repurchase program
PMI's strong cash flow has led to the firm conducting share repurchases. The company announced an $18 billion, three-year share repurchase program in August 2012. PMI spent 11.9 billion to repurchase 135.3 million shares through September 30, 2014. On account of the volatile currency environment, the company decided not to purchase any shares in 2015 and 2016.
Trefis Forecast Rationale for Philip Morris International Market Share in Asia
Philip Morris International's Market Share in Asia is the ratio of the volume of cigarettes sold by Philip Morris International to the total volume of cigarettes sold in Asia every year.
Philip Morris International's market share in Asia jumped to 24.2% in 2010 from 19.7% in 2009 with the merger of Philip Morris International and Fortune Tobacco Corp in the Philippines. In 2011 and 2012, the market share grew further to 26.5% and 27.3% respectively. However, in 2013, the company's market share in Asia declined to just 25.8% as it lost significant ground to its prime local competitor in the Philippines. In 2014, market share in the region declined to an estimated 25.8% as the company lost share in key markets such as Indonesia, Japan, and Korea. 2015 saw a gain in market share to 26.1%, primarily due to gains in Indonesia, Korea, and the Philippines.
Going forward, we expect the market share to increase gradually to around 31.6% by the end of the Trefis forecast period with major gains in Japan, Indonesia, and potentially the Philippines.
Trefis considered the following factors for its forecast:
- Share Gains Expected In Japan Against Innovations
- Philip Morris holds over 25% of the market in Japan. Although Japan has been challenging, we anticipate market shares to grow in the country. In 2013, Japan underwent consumption tax hikes, which translated into unit price hikes. In response to this, Philip Morris experienced share losses of one percentage point, as customers traded down to cheaper alternatives to some extent.
- In order to stabilize market shares, Philip Morris resorted to new campaigns such as the Don’t Be A Maybe, Be Marlboro campaign. Furthermore, 2014 saw new launches for Marlboro and Lark. During FY 2015, the iQOS launch was expanded in Japan to reach 60% of the adult smoking population. In Japan, the weekly offtake shares - retail sales volume for heatsticks as a percentage of the total estimated retail sales volume for cigarettes and heatsticks - have climbed steadily since the expansion began in September.
- We expect market share gains in Japan in 2016 against further innovations. Going forward, Philip Morris plans to incorporate a range of colors and textures in this realm, to create greater appeal for the product.
- Philippines could see share gains in spite of headwinds
- In 2010, Philip Morris International merged with Fortune Tobacco Corporation to form a new company called PMFTC to control a large chunk of the Philippines tobacco market. In spite of a decline in the total cigarette consumption in the country in 2011 and 2012, Philip Morris continued to consolidate itself in the market.
- 2013 witnessed a growing prominence of economy brands, which adversely impacted Philip Morris' almost monopolistic hold in the market as consumers increasingly down-traded to competitor's brands in lower price points. Philip Morris faces intense competition from a local competitor, Mighty Corp., who landed 24% of the market from single digits since 2013, while Philip Morris went from 90% to about 70% share.
- 2013 also witnessed a sin tax law, which resulted in an increase in the unit price of cigarettes. The higher prices of Philip Morris' brands against increasing taxes, and as an attempt to mitigate losses from volume declines, has also resulted in share losses to a growing illicit market.
- 2015 saw the estimated total consumption decrease by 4.9%, mainly due to the impact of price increases. The decline in PMI's cigarette shipment volume reflected the lower total market combined with lower consumption of low and super-low price brands, following price increases in late 2014 and early 2015, partly offset by higher market share, driven by adult smoker uptrading to Marlboro, combined with market share growth of Fortune, reflecting the narrowing of retail price gaps with brands at the bottom end of the market.
- Philip Morris could see some share gains going forward, albeit slowly. This is because, although 2014 saw increases in Philip Morris and the competition's unit prices, in a way that the price differential between the two has been reduced. In this situation, customers could trade up to a better and more renown brand going forward.
- Growth prospects in the large Indonesian market
- The Indonesian cigarette market constitutes approximately 25% of the Asian cigarettes market by volume. PMI occupies more than a third of Indonesia's market and ties up with local heritage brands like Sampoerna A and Dji Sam Soe to maintain a broad and deep product portfolio to compete effectively across all price segments.
- The estimated total cigarette market in Indonesia was essentially flat, reflecting a soft economic environment. The slight increase in PMI's market share reflected a strong performance from machine-made kretek brands, notably Sampoerna A, Dji Sam Soe Magnum and Dji Sam Soe Magnum Blue, largely offset by U Mild, and a decline in hand-rolled kretek portfolio, notably due to Sampoerna Hijau in "Others," down by 0.4 points to 3.0%.
- Going forward, increasing popularity of the kretek segment, along with further innovations, could guarantee share gains for Philip Morris. However, the market continues to remain vulnerable to legislations that could ban the use of flavor additives to cigarettes.
Back to Company Overview
- Lower market share in Korea against massive tax hikes
- Philip Morris International witnessed strong growth in South Korea in the past, led by the Marlboro and Parliament premium brands. Shipment volumes grew by 100% between 2006-2010 and market share doubled from 8.5% in 2006 to 19.8% in 2011. In 2012, the company cut the price of its Virginia Slim cigarettes by 14% to extend its market share in the country. In 2013 and 2014, market share remained more or less flat at 19.4%. 2015 also saw a rise in market share to 21.2%
- The decline of the estimated total cigarette market in Korea reflected the impact of the January 2015 excise tax increase and related retail price increases. Excluding the impact of estimated inventory movements associated with the timing of the excise tax increase, the total cigarette market declined by approximately 17.3%. The decline in PMI's cigarette shipment volume reflected the lower estimated total market, partly offset by share growth, driven by Marlboro, benefiting from the positive impact of pricing for their principal domestic competitor's main brands.
- Going forward, we expect both the total cigarette market and Philip Morris' share in the market to shrink. In December 2015, the government introduced a Revised Tobacco Business Act, which requires manufacturers to change brand names and introduce cigarettes with lower ignition properties, with the aim of reducing the incidence of smoking. Furthermore, effective January 1st, Korea will see a 120% increase in total tobacco excise tax. In response to this, Philip Morris plans to increase the price of key-brands, Marlboro and Parliament, by close to 67%. These price hikes are expected to drag down the market by close to 20-25%. Philip Morris stands to lose significant share to illicit producers and other cheaper alternatives in the market.
- Anti-tobacco legislation
- Legislations for ingredient disclosure and a ban on smoking in public areas in different countries may hurt cigarette sales. The Tobacco Plain Packaging Bill in Australia, which was recently approved by the country's Supreme Court, requires all cigarette companies to sell their products within the country in generic olive-green packs with large graphic warning labels. This will cause erosion of brand value for the cigarette companies, and can lead to a substantial reduction in sales and market share. Further, France, Ireland, and the U.K. have adopted plain packaging legislation and governments of other countries, such as India, and Canada, are keeping a close watch on the bill, and may implement similar measures in their countries as well.
How Does Trefis Modelling Work?
How do we get the historical numbers for this chart?
Trefis has a team of in-house Analysts who gather historical data from company filings and other verifiable sources. When historicals are available, we explain how we got them at the bottom of the Trefis analysis section below.
Who came up with the Trefis forecast for future years?
The Trefis team of in-house Analysts considers a variety of factors when projecting any forecast. The rationale for our projections is explained in the Trefis analysis section below.
How does my dragging the trendline on the chart impact the stock price?
- We use forecasts for business drivers to calculate forecasted Revenues and Profits for each division of the company.
- We then use forecasted Profits in a Discounted Cash Flow (DCF) model to obtain the Price Estimate for the company.
See more on: DCF Methodology
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