IQOS Drives Philip Morris’ Growth In 2018; Outlook Remains Bright

by Trefis Team
Philip Morris International
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Philip Morris International (NYSE: PM), manufacturer of cigarettes and other nicotine containing products including reduced-risk products, announced its Q4 2018 results on February 7, 2019 followed by a conference call with analysts. The company beat market expectations by posting revenue of $7.5 billion in Q4 2018, 9.6% lower compared to Q4 2017; and adjusted earnings per share of $1.25, a decline of 5.35% over $1.32 in Q4 2017. Lower revenue and earnings for the quarter were a result of a 4.6% decline in total shipments, mainly attributable to negative distributor inventory movements in Japan and adverse effects with strengthening of the dollar. Full year revenue came in at $29.6 billion, 3.1% higher than in 2017, due to favourable pricing variance and strong growth in heated tobacco unit volume.

We have summarized the key takeaways from the announcement in our interactive dashboard – Strong Pricing Mix Helps Philip Morris Beat Consensus In 2018. We have a price estimate of $87 per share for the company, which is higher than its current market price.


Key Factors Affecting Earnings

Lower cigarette shipments: The demand for combustible products has seen a gradual but steady decline in the last few years as cigarette consumption among youngsters has taken a hit due to increased awareness, health concerns, and a switch to e-vapor. Total cigarette shipments saw a decline of 3.1% in Q4 2018; and for the full year, volume was down by 2.8%. The company has adopted price rises as a strategy to sustain sales in the face of falling shipments.

iQOS:  IQOS, the smoke-free product portfolio which includes heated tobacco and nicotine containing vapor products, has seen sales pick up since its launch in 2017 as more and more people are switching to heated tobacco products which are considered to be less risky. Heated tobacco shipments increased by 14.2% in 2018 compared to the previous year. However, the growth was less than expected as volumes saw a decline of 22.6% in Q4 2018, mainly due to negative distributor inventory movements in Japan. Though margins for the product are very low currently due to discounts and offers as the company is trying to promote the product, we expect IQOS to drive the company’s future growth and create value for the company as the discounts are gradually withdrawn.

[Source: Philip Morris’ Q4 2018 Earnings Presentation]

Eastern Europe, Middle East and Asian Dynamics Remain Weak: The total market share in Eastern Europe decreased by 7.1%, mainly driven by Russia and Ukraine which were adversely affected by the timing and impact of excise-driven retail price increases as well as an increase in illicit trade. Shipments from Eastern Europe were down by 5.3% in 2018. The Middle East was mainly affected by Saudi Arabia and UAE – market share in both the regions was down by over 20% in a year – primarily reflecting the impact of price increases and the introduction of the new excise tax in 2017 and VAT in January 2018. Net revenue in Asia and Australia was lower by 12.4% and shipments decreased by 13% compared to the previous year due to lower sales in Australia and Japan – being affected by unfavorable inventory movements – and Korea where sales were low after implementation of graphic health warnings in 2018.

Profitability: For the full year, net income margin increased sharply from 7.7% in 2017 to 9.9% to 2018, mainly due to a reduction of almost $1.9 billion in tax expense for the year. The effective tax rate in 2018 was down to 22.9% from 40.7% in 2017 because of the implementation of Tax Cuts and Jobs Act. As a step toward optimizing its capital structure, the company also used its high cash balance to pay off $2.5 billion of its 10-year U.S. bond in May 2018, which with a coupon of 5.65%, was the most expensive debt instrument on the company’s books. This helped the company reduce its interest expense by close to $250 million during 2018.

Safe Bet For The Long Term

We expect the company to post higher earnings per share of $5.35 in 2019 on the back of increased revenue and higher margins. Though slower than expected progress in the growth of IQOS has led to Philip Morris’ stock experiencing immense beating in the last few months, we believe that the expected pick-up in the heated products segment would drive revenues higher in 2019 and beyond. Lower interest and tax outgo, coupled with a gradual phasing out of the discounts on IQOS will drive profitability with net income margin expected to be slightly higher at 10% in 2019. As per our analysis of the company’s performance, the stock still has an upside potential from its current levels and growth in IQOS would likely be the catalyst to drive the expected uptick in the stock price.


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