More Impressive News Regarding iQOS In Philip Morris’ Fourth Quarter

by Trefis Team
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Philip Morris International
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Philip Morris International‘s (NYSE:PM) earnings miss was largely overlooked in an otherwise impressive fourth quarter, when revenues came in higher than expected, driven by increasing sales of the company’s heat-not-burn device – iQOS. While cigarette volumes fell as expected, a 2.1% drop, PM recorded heated tobacco shipment volume of 15.72 billion, an over 300% jump. The immense growth in the iQOS sales resulted in a favorable volume mix variance of $1.1 billion, PM’s best ever performance on this measure.

While the year may not have started on the best note, with the rejection of PM’s proposed claim that its iQOS device presents less of a health risk than traditional cigarettes, by an advisory panel instituted by the FDA, it doesn’t mean that the end won’t be good. The development of reduced risk products, such as iQOS, has been a boon for the company, as it can help reverse the declining volumes it has been faced with recently. And it is this product that the company intends to market as one that can ultimately replace cigarettes. The increased sales of iQOS can be expected to be the main driver for revenue growth in the future, and with the company noting a positive annual profit contribution from its RRP (Reduced Risk Product) portfolio for the first time, looking ahead the margin pressure should also ease.

Eastern Europe, Middle East, And Africa (EEMA) Segment Dynamics Remain Weak

  • The 2017 results from the region were significantly impacted by two markets – Russia and Saudi Arabia.
  • Total industry volume fell 7.2% in Russia due to excise-driven price hikes, together with the prevalence of illicit trade. Despite down-trading by consumers, PM’s market share remained stable. Net pricing, on the other hand, remained challenged due to a competitive environment. Consequently, the company could not nullify the financial impact of the volume decline. While excise tax increases in the region usually occur in January, it is scheduled for July this year, with the weighted-average total excise tax pass-on for the industry being approximately RUB5 per pack, compared to RUB13 last year. Accordingly, PM expects to return to profitable growth this year.
  • An excise tax-driven price increase in June 2017, resulting in a doubling of cigarette retail prices, drove a cigarette industry volume decline of approximately 28% in the second half and 17% for the year. The price hikes caused significant down-trading among consumers, resulting in market share declines for premium Marlboro and mid-price L&M. These factors weighed on the profitability of the company from the region, with the impact set to continue in the first half of FY 2018.
  • Moreover, the other five GCC (Gulf Cooperation Council) countries are also in various stages of implementing a similar excise tax increase, with the United Arab Emirates having already done so in the fourth quarter of 2017. As a result, considerable volume and profit pressure can be anticipated across the area this year. Saudi Arabia and the United Arab Emirates accounted for approximately 60% and 20%, respectively, of the GCC’s cigarette industry volume prior to the 2017 tax increases.

iQOS’ Phenomenal Run Continues

  • The strong performance of iQOS in Japan helped in increasing the total cigarette and heated tobacco unit volume by 30%.
  • The market share of the Marlboro HeatSticks grew by 9 points to 13.9% in the fourth quarter, and reached 14.1% for the month of December, while the offtake share increased by 1.4 points to 19.9% in Q4. This was despite the capacity limitations of HeatSticks at first, and iQOS devices later. The supply is reported to no longer be an issue, placing the company in a good position to take on 2018.
  • Korea, another key market for iQOS, also reported exceptional performance, with the fourth quarter market share of HeatSticks more than doubling sequentially to 5.5%, reflecting growth in existing launch areas, coupled with the impact of national distribution expansion.
  • The incremental RRP spending for 2018 is projected to be approximately $600 million, equating to a drag of roughly 6 points on the company’s projected EPS growth of 7% to 10%.

We have a $125 price estimate for Philip Morris, which is higher than the current market price. The charts above have been made using our new, interactive platform. You can click here to modify different drivers, and see their impact on the EPS and price estimate for Philip Morris.

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