What’s Ahead For Philip Morris After Beating Estimates In The Third Quarter?

by Trefis Team
Philip Morris International
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Philip Morris International (NYSE:PM) handily beat consensus estimates in the third quarter, reporting revenue growth of 0.4%, a currency-neutral revenue increase of 3.3%, and adjusted earnings per share improvement of 13.4%.  The revenue growth was a result of price increases for its combustible tobacco portfolio, partially offset by the negative impact of inventory movements of its heated tobacco units. Higher sales, a reduced tax rate, and lower interest expenditure helped in the earnings increase. Looking ahead, the company has guided for a full-year net revenue growth of approximately 3%, excluding currency, and EPS to be in the $4.97 to $5.02 range. Given the fact that year-to-date, the company’s revenue growth has been 6.5%, it would imply a revenue decline of roughly 5% in the fourth quarter. This is primarily due to a tough comparison versus the impressive 19% growth reported in the fourth quarter of last year, along with the fact that the sales of both cigarettes and heated tobacco units in the third quarter increased in anticipation of the price increases on October 1. Hence, the volumes in Q4 may end up being lower as a result. This factor, together with the increased RRP (reduced risk product) spending of $600 million, which is skewed towards the fourth quarter, also resulted in the decline in EPS expected in the fourth quarter.

We have a $105 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 for our dashboard on Our Outlook For Philip Morris In FY 2018 to modify different drivers, and see their impact on the revenue, earnings, and price estimate for Philip Morris.

How Did iQOS Do In The Third Quarter?

After the heady growth reported by the device and its HeatSticks/HEETS up till FY 2017, much was anticipated. However, disappointing performances in the first and second quarter, which resulted in a substantial decline in the company’s stock price, have tamed analysts’ expectations, and hence, a decent showing in Q3 sent the shares up on both Thursday and Friday. The poor showing in the first half led to a massive inventory reduction of the device, which was concentrated in the third quarter. Consequently, the company feels the inventory has now been right-sized, placing it in a better position for future growth.

Growth in the iQOS user base continued in the third quarter, resulting in market share improvement, reaching 1.7% of total cigarette and heated tobacco unit industry volume, excluding China and the U.S. In Japan, its largest iQOS market, the company recorded stable quarterly HeatSticks share on a sequential basis. This is encouraging, given the number of steps PM is undertaking to accelerate HeatSticks’ performance in the face of the weak growth and increased competitive pressure, including the upcoming launch of iQOS 3 and iQOS 3 Multi, which are expected to bear fruit starting next year.

In Korea, another big market for iQOS, while the volume growth was stable on a sequential basis, the market share declined. The company has stated the liability for this rests primarily on the actions of the Korean government and FDA, which has resulted in confusion among the adult consumers with regard to the heated tobacco category. The Korean government has commenced discussions on graphic health warnings for heated tobacco products, while the Korean FDA has mischaracterized the tar generated by the device, a claim the company has refuted based on scientific evidence.

Strong growth for the device continued in the EU, with the share reaching 1.2% and reflecting further growth in the iQOS user base. Furthermore, the quarterly share for HEETS increased in all iQOS markets in the region compared to the third quarter of 2017. The momentum of the device in Russia also remains favorable, with the share for HEETS reaching 1.1% nationally, despite the company focusing currently on key cities comprising just 20% of the total cigarette market in the country.

For the full year, the company expects its total shipment volume to be down roughly 2%, with growth in HeatSticks volume partially offsetting the cigarette shipment decline. PM anticipates its heated tobacco unit shipment volume to be 41 billion to 42 billion units for the year, reflecting a net anticipated distributor inventory reduction of approximately 3 billion units, and heated tobacco unit in-market sales volume of 44 billion to 45 billion units.

What Other Factors Impacted Performance?

1. Pricing Variance Remains Strong: PM’s combustible tobacco portfolio reported impressive growth as a result of strong pricing variance, which helped to offset the volume decline. The combustible pricing variance in Q3 was approximately 8%, driven notably by the EU, Indonesia, the Philippines, and Russia. For the full year, the company is anticipating a pricing variance of 7%.

2. Performance In Saudi Arabia Moderating: Though the declines improved on a sequential basis, the cigarette industry volume and PM sales volume had remained under pressure in the second quarter, declining by about 24% and 40%, respectively. This trend reversed in the third quarter, reflecting the lapping of the June 2017 excise tax implementation. Consequently, the total shipment volume in the region was up by 18.5%, reflecting a higher market share of 6.1 points.

3. iQOS Application In The U.S.: Philip Morris, together with Altria, is in the process of gaining FDA approval to start selling its heat-not-burn tobacco device called iQOS with a reduced risk claim in the U.S.  While PM was the first company to file for an FDA approval for its heat-not-burn device, competitor BAT has stated that it has gained approval to sell its own device in the U.S. market, and is expected to begin testing it by the end of 2018. Philip Morris, on the other hand, is hoping to hear back from the FDA before the end of the year.

4. Reduced Tax Rate: Philip Morris is expected to get a boost to its earnings as a result of the overhaul of the corporate tax code, which reduced the tax rate from 35% to 21%, effective January 1, 2018. Its tax rate is expected to fall from 44% in FY 2017 to approximately 24% in FY 2018.

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