Why Did Philip Morris’ Shares Have Their Biggest One Day Drop?

by Trefis Team
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Philip Morris International
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Philip Morris International (NYSE:PM) reported its first quarter earnings on April 19, and saying investors weren’t quite pleased with the results would be an understatement. The shares of the company plunged 16% in the aftermath of the results announcement, its biggest one-day drop since 2008 when the company split from Altria. While the earnings came in above consensus estimates, the revenues missed by about $100 million. The main reason for all the negativity was the disappointing quarter for iQOS, its heat-not-burn device, which had been delivering heady growth till the previous quarter. A seemingly plateauing market in Japan, the biggest market for iQOS, was the main cause for worry. However, the device’s tremendous growth potential globally needs to be considered, besides the fact that growth is still possible in Japan.

We have a $124 price estimate for Philip Morris, which is substantially higher than the current market price. The charts 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.

What Happened In Japan?

Shipment volume of HeatSticks in Japan had been curtailed up till the fourth quarter of last year as a result of capacity limitations. This restriction was lifted in the first quarter. However, the device sales growth was lower than the ambitious target that the company set for itself. So why did this happen? While a small blame can be attributed to the lack of awareness regarding the increased availability of iQOS, much of the liability rests on the fact that the company may have largely met the demand of the so-called “innovators” or “early adopters.”  Meanwhile, the more conservative consumers, especially those who are aged 50 years or more, are a more difficult segment to capture. These consumers represent a mammoth 40% of the total adult smoking population, and hence, the commercial plans, in terms of timing, intensity, and content of communication, needs to be looked into and altered, keeping this segment in mind.

iQOS currently holds 80% of the heated tobacco market in Japan, and while the “innovators” may have been experimenting with other heat-not-burn devices in the market, less than 1% of them actually end up switching, which is quite impressive, given the premium positioning of PM’s device. HeatSticks have captured 15.8% of the national market share in the country, representing a growth of just 1.9 points versus the fourth quarter of last year, and lower than the 16.3% share disclosed in January at the CAGNY presentation.

Philip Morris has switched to sea shipments, from air shipments earlier, and as a result, it takes about six to eight weeks for the heated tobacco shipment to arrive in Japan from Europe. The company had started to build inventory in the country, and moreover, some of the shipments in Q4 2017 arrived in Japan in January or February. The company also recognizes revenue when the product ships out of Europe. As a result, the shipment volume and RRP (reduced risk product) revenue fell in the first quarter, as compared to Q4 2017, due to the volume sold in Q1 2018 being accounted for in Q4 2017.

Saudi Arabia Continues To Remain A Drag

The cigarette market in Saudi Arabia remains under much pressure following the June 2017 excise tax-driven price increases. The industry volume in Q1 declined by over 40% and was impacted by a further VAT-driven price increase in January. The price hikes caused significant down-trading among consumers, resulting in market share declines for premium Marlboro and mid-price L&M. For the company as a whole, the market share declined by 12.5 points in the region. Furthermore, considering Saudi is a high margin area, weakness in the region will pressure the overall margins of Philip Morris. The company anticipates a moderation in the cigarette industry volume decline in the second half of the year. The entire GCC (Gulf Cooperation Council) area remains one to be kept a close eye on, as other countries are also in various stages of implementing a similar excise tax increase.

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