Philip Morris’ Earnings Drop Despite Growth In Top Line In Q1 2019; Full Year Outlook Revised Downward

Philip Morris International (NYSE: PM), manufacturer of cigarettes and other nicotine containing products including reduced-risk products, released its Q1 2019 financial results on April 18, 2019, followed by a conference call with analysts. The company reported revenue of $6.75 billion in Q1 2019, marking a growth of 2.1% over Q1 2018. Higher revenue was mainly driven by a 20.2% increase in the shipment of heated tobacco products and favorable pricing for combustible products. Additionally, increasing market share of the company in the heated products segment and volume growth from each of the company’s top five international cigarette brands contributed to the growth in the top line. However, PM missed consensus estimates on earnings. The company reported adjusted earnings of $0.87 per share in Q1 2019, much lower than market expectation of $0.97/share and $1.00/share in Q1 2018. Lower earnings were mainly a reflection of a  loss of $0.09 per share due to Canadian tobacco litigation-related expense and $0.12 per share due to deconsolidation of Canadian subsidiary Rothmans, Benson & Hedges Inc. (RBH) under U.S. GAAP.

We have summarized the key announcements in our interactive dashboard – How did Philip Morris perform in Q1 2019 and what is the outlook for the full year? In addition, here is more Consumer Staples data.

Key Takeaways

Revenue from Combustible Products Segment

• Under the combustible products segment, the company predominantly sells American blend cigarette brands, such as Marlboro, L&M, Parliament, Philip Morris and Chesterfield.
• In spite of cigarette shipments in Q1 2019 remaining constant at 164.3 billion units, same as the previous year period, revenue from combustible products declined by 4.5% (y-o-y) in Q1 2019.
• Lower revenue was mainly due to the impact of unfavorable currency which adversely affected the segment revenue by $340 million for the quarter.
• Excluding the currency effect, revenue from combustible products increased by 1.4%, mainly driven by increased pricing.

Revenue from Reduced-Risk Products Segment

• Under the reduced-risk products segment, PM sells its flagship IQOS devices and heated tobacco units.
• Revenue from the segment increased by 10.3% (y-o-y) in Q1 2019, mainly due to increase in volume.
• Shipments of heated products increased sharply by 20.2% from 9.6 billion units in Q1 2018 to 11.5 billion units in Q1 2019.
• This increase was mainly due to a switch away from combustible products and higher demand for e-vapor from millennials.
• The company has been able to increase the market share for its heated product segment in EU region, Japan, and Russia.

Profitability

• Net income margin decreased to 20.1% in Q1 2019 compared to 22.6% in Q1 2018.
• Margins for the quarter were affected due to Canadian tobacco litigation-related expense of $194 million and loss of $239 million on deconsolidation of RBH.
• Both these charges were included in the marketing and administration cost which witnessed an increase of close to 21%.
• This was partially offset by lower interest expense in Q1 2019 compared to Q1 2018, as the company used its high cash balance to pay off $2.5 billion of its 10-year U.S. bonds in 2018, which, with a coupon of 5.65%, was the most expensive debt instrument on the company’s books.

Full Year Outlook

• For the full year, we expect net revenue to increase by 3.5% to $30.7 billion in 2019 from $29.6 billion in 2018, as sales under the company’s heated tobacco segment are expected to pick up further in the second half of the year.
• However, net income margin is expected to be adversely affected due to litigation expenses and deconsolidation losses, partially offset by lower interest and tax outgo, coupled with a gradual phasing out of the discounts on IQOS.
• We expect net income margin to decline to 24.8% in 2019 from 26.7% in 2018.

Trefis has a price estimate of $89 per share for the company’s stock. Though PM’s stock price declined after the Q1 2019 announcement in which the management revised its full year EPS outlook downward, this reduction in EPS is not because of a change in the company’s fundamentals but mainly due to one-time expenses for the year. Although Philip Morris does not have US operations, the industry as a whole faced pressure with plans of proposed legislation to raise the legal age to purchase tobacco products to 21 from 18 in the U.S. We believe that with the fundamentals of the company being strong, rising market share of its products in major markets, expectation of the FDA making a ruling on IQOS (PM’s major offering in the heated product category) in 2019, and a higher dividend pay-out, these would support growth in the stock price.

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