Philip Morris International (NYSE:PM) reported higher third quarter earnings this Thursday, as it was able to more than offset the continued decline in sales volume through improved pricing. Despite significant currency headwinds, the company reported a 4.3% jump in earnings per share (EPS) adjusted for one-time items. EPS adjusted for the negative impact of a stronger U.S. dollar and special items grew 11% y-o-y. However, the company lowered its full year diluted EPS target range due to a potentially higher unfavorable currency impact and some restructuring costs during the fourth quarter. 
During the quarter, Philip Morris’ total cigarette shipment volume declined 6% y-o-y, attributable to the decline in the overall global taxed cigarette market. This is also evident from the fact that the company’s volume market share actually improved year-on-year in all but one operating region – Asia. Philip Morris lost significant market share in the Philippines to its prime local competitor on pricing concerns amid a steep excise tax hike implemented earlier this year. Furthermore, the company was also able to realize meaningful consolidated pricing gains to more than offset the sharp decline in volumes. This reflects Philip Morris’ price-taking capability based on a healthy brand portfolio. 
We currently have $87 price estimate for Philip Morris International, which we will soon update to incorporate the third quarter earnings results.
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Philip Morris International is a leading international tobacco company with its products sold in more than 180 countries worldwide. Until its spin-off in March 2008, it was an operating company of Altria Group (NYSE:MO). Excluding the U.S. and China, the company holds more than 28% of the total international cigarette market, which is led by its flagship brand Marlboro.
Anti-Tobacco Measures Drag Volumes
Philip Morris’ third quarter cigarette shipments declined in all of its operating regions due to sharp cuts in the European Union (EU), the Philippines and Russia. Increased excise taxes, high unemployment rates due to weak macroeconomic conditions, the growing prevalence of illegally traded cigarettes, and shifting consumer preferences towards other tobacco products (OTP) are some of the key factors dragging down cigarette consumption in the EU. Philip Morris’ shipment volumes in the region dipped by 5% y-o-y during the third quarter and by 7% y-o-y for the first nine months as a result of these factors.  We expect the full year shipment volumes to the EU to decline by 7% as we do not see these trends easing drastically in the short term.
Almost 30% of the total volume decline reported by Philip Morris for the third quarter can be attributed to the Philippines where a sharp hike in indirect taxes implemented earlier this year disrupted an otherwise flourishing tobacco industry. Following the tax hike, the company increased prices of its Marlboro and Fortune brands by around 60% and 70%, respectively. As a result, Philip Morris recorded more than a 20% decline in cigarette shipments to the market during the third quarter. The company expects its full year volume in the Philippines to decline by 20-25%, in line with our estimates. The Philippines is one of the key markets for Philip Morris as it contributed 22% to the company’s shipments to Asia last year. 
Russia, the world’s second largest market for cigarettes, further aggravated operating conditions for Philip Morris during the third quarter. Shipment volumes in the country declined more than 10% as a result of the implementation of excise tax hikes and other anti-tobacco measures. The Russian anti-tobacco bill that was signed into law on February 25, 2013, came into effect on June 1. The law primarily aims at lowering annual smoking-related casualties in Russia by half over the next decade by restricting the marketing and sale of cigarettes and smoking in public areas. According to the World Health Organization (WHO), the public smoking ban is the most effective tool for reducing smoking prevalence after indirect taxes. (See: What’s The Impact of Russia’s Anti-Smoking Law On Philip Morris?)
Pricing Measures Drive Earnings Growth
The relatively inelastic demand for cigarettes, coming primarily from their addictive nature, allows tobacco companies to drive earnings growth through pricing measures, despite lower volumes. Philip Morris’ third quarter results are a prime example of this trend that is prevalent across the global tobacco markets. Despite the sharp decline in shipment volumes, the company was able to post more than 2% growth in adjusted operating income. The lower effective income tax rate and reduced outstanding shares further boosted the company’s EPS growth. The fact that Philip Morris was able to sustain and improve volume market share in most of its geographically diverse portfolio despite hefty pricing gains bolsters our faith in its brand portfolio. Since we expect shipment volumes to remain depressed during the fourth quarter as well, Philip Morris will have to rely primarily on its pricing strength to meet its earnings growth target for the year. The company’s diluted EPS adjusted for one-time items and currency fluctuations has grown by ~7% y-o-y during the first nine months of the year. Philip Morris is targeting to grow that figure by 10% for the full year. Notes: