Philip Morris International (NYSE:PM) reported its first quarter earning results on April 18. As expected, the company witnessed a sharp decline in cigarette volumes primarily due to an abrupt hike in indirect taxes in Philippines and continuing weakness in the European Union amid uncertain macroeconomic conditions coupled with excise tax driven price hikes on cigarettes. (See Philip Morris Earnings Face Headwinds From Anti-Tobacco Laws) Excluding excise taxes, revenues for the first quarter, which exclude the impact of currency movements as well, grew 3.1% y-o-y driven by favorable pricing across regions. Cigarette shipment volume declined sharply by 6.5% led by Asia (down 10.4%), European Union (down 10.1%), Latin America and Canada (down 7.5%) partially offset by the Eastern Europe, Middle East and Africa (up 1.4%).
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The company also lowered its 2013 full-year earnings forecast to be in the range of $5.55 to $5.65 for currently prevailing exchange rates. Previously the company guided its full year EPS to be in between $5.68 and $5.78 on February 20th, 2013. It should be noted that the change in earnings forecast has been attributed to worsened expectations of unfavorable currency impact from $0.06 to $0.19 per share. 
Sharp Tax Hike In Philippines Leads To Volume Slump In Asia
Excluding the negative impact of currency, Philip Morris reported 4.8% growth in net revenues for the first quarter in Asia. Revenue growth in the region reflected favorable pricing in Philippines, Australia and Indonesia driven by higher excise taxes.  Higher net pricing was partially offset by unfavorable volume mix in Philippines where cigarette volumes slumped by 42.5% due to abrupt hike in indirect taxes implemented on January 1, 2013.  It should be noted that the impact of hike in excise taxes was magnified in the first quarter due to large inventory build-up in the fourth quarter of 2012, in anticipation of the implementation of these tax hikes.
Since the Philippines market is the top three by shipment volume in Asia for Philip Morris contributing to as much as 28% of the volume shipped by the company in Asia during 2012, such a sharp decline in volumes in the country was bound to impact the company-wide volumes drastically.  However, the Philippines effect was partially diluted by the growth in shipment volume seen in Indonesia (up 4.9%) and Japan (up 6.9%).
Going forward, we expect the rate of volume decline in Asia to moderate to around 6-8% for the full year as the trade inventories in Philippines are expected to normalize over the coming months.
EU Cigarette Volumes Continue to Decline
The total cigarette market in the EU declined by 10.5% on excise tax-driven higher prices, uncertain macroeconomic environment, increasing illicit trading of cigarettes and the growth of other tobacco products (OTP) segment. A recent study by KPMG revealed that illicit trading of cigarettes in the EU has reached record high levels in 2012 resulting in huge tax losses to the member states.  The market decline in the EU was led by Spain (down 15%), Poland (down 10.4%), Italy (down 9.5%), France (down 8.6%), and Germany (down 6.6%). Philip Morris reported a 10.1% decline in cigarette shipment volume in the EU during the quarter primarily due to lower total market volumes while increasing its market share by 70 basis points y-o-y to 38.1% in the region.
The growth of lower priced other tobacco products (OTP) is also a factor driving cigarette volumes lower in the EU. In most countries, excise taxes on tobacco products other than cigarettes (cigars, cigarillos, fine-cut tobacco for hand-rolling cigarettes, pipe tobacco, snus, chewing tobacco and so on) are subject to much lower excise tax levels compared to manufactured cigarettes which makes them relatively cheaper. Philip Morris’ shipments of OTP in cigarette equivalent units grew by 6.9%, reflecting a higher total market and share.
We expect the declining cigarette volume trend in the EU region to impact the company’s performance throughout 2013, as most of the factors responsible for lower shipment volumes in the region including high unemployment rates, higher excise taxes and growing illicit trade of cigarettes are expected to remain challenging over the coming months as well.
Russia Drives EEMA Volumes Higher
In EEMA, Philip Morris reported a sharp 10.8% increase in net revenues, excluding the impact of currency, driven by higher pricing, primarily in Russia, Turkey and Ukraine and a favorable volume mix impact. Cigarette shipment volume in the region increased marginally by 1.4%, reflecting higher shipments in Russia partially offset by sharply lower shipments in Turkey. The sharp 17.4% decline in shipment volumes in Turkey was due to unfavorable reversal of the huge inventory build-up in the fourth quarter of 2012, ahead of the planned hike in special consumption tax implemented on December 31, 2012. After adjusting for currency movements, the company’s operating income from EEMA region grew by 15.8% y-o-y driven by higher net pricing led by excise tax hikes in Turkey and Ukraine.
Going forward, we expect cigarette volumes in the EEMA region to decline for the full year following the implementation of the anti-tobacco law in Russia on June 1 2013. The law aims at bringing down smoking rates in the country drastically by banning smoking in public places, including hospitals, government offices and public transport, restricting marketing and sales of tobacco products and increasing excise taxes. (See: What’s The Impact of Russia’s Anti-Smoking Law On Philip Morris?) Since Russia contributes to almost one-third volume shipped by the company in EEMA, the impact of lower volumes in Russia is expected to be significant. 
We will update our $86 price estimate for Philip Morris based on the recent developments.
- First Quarter Earnings Results, www.pmi.com [↩]
- Indonesia, www.tobaccotax.seatca.org [↩]
- 2013 Consumer Analyst Group of Europe (CAGE) Conference, www.pmi.com [↩] [↩] [↩]
- Philip Morris International: New Study Finds EU Black Market for Cigarettes Reaches Record High; Member State Tax Loss an Estimated EUR12.5 billion, www.wsj.com [↩]