Can Philip Morris Provide Some Positive iQOS News In The Second Quarter?

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PM: Philip Morris logo
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Philip Morris

Philip Morris International (NYSE:PM) is set to release its second quarter earnings on July 19, wherein revenue and EPS growth of 9.4% and 8.8% are expected, as compared to the corresponding quarter of the previous year. Revenue growth is set to be driven by increased sales of its reduced risk products (RRPs), iQOS in particular, as well as price increases, while a reduction in the tax rate is expected to be the primary driver in the earnings improvement. PM had 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. The decline has not let up till now, with the stock price falling from $101.44 on April 18 to $81.92 on July 16, a fall of roughly 19%. The main reason for all the negativity was the disappointing quarter for iQOS, its heat-not-burn device, which had been delivering heady growth up till Q4 2017. A seemingly plateauing market in Japan, the biggest market for iQOS, was the main cause for worry, and hence, this device’s performance will be a key factor impacting the stock performance post the earnings release.

We have a $114 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 revenue, earnings, and price estimate for Philip Morris.

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All Eyes on iQOS

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’s sales growth was lower in the first quarter 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.

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 conference. On the other hand, what was probably overlooked is that in such a short time HeatSticks has already become the second largest tobacco brand in Japan, having a share that is nearly double that of Marlboro cigarettes. Moreover, iQOS is the undisputed heated tobacco segment leader, with an estimated 5.4 million consumers, representing around 76% of the category. Moreover, 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.

Despite the blip in Q1, the company anticipates the sales of HeatSticks to more than double in volume in 2018, along with a substantial rise in its profit contribution, even though the company is expected to continue its sizeable investments. PM remains fairly certain that the product will grow in every market it has been launched in, including Japan. The company has also laid out its target for 2025 – achieving 30% of its volume from RRPs. This could potentially represent $17 to $19 billion of RRP net revenues, or 38% to 42% of total PMI net revenues. A promising factor for PM is that the switching rates for iQOS are pretty high, with full and predominant conversion usually ranging from around 70% to 90% across markets.

Saudi Arabia May Continue To Be 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 have 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 in Q1 2018. 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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