Where Is Philip Morris Spending Most Of Its Money?

Philip Morris’ (NYSE: PM) total expenses have trended steadily higher from around $67.7 billion in 2016 to about $71.5 billion in 2018. As a percentage of revenues, expenses have remained around 90% during the same period. Company’s expenses are largely driven by excise taxes and cost of sales. The two expense heads together account for about 76% of revenues as of 2018, reflecting a drop from 77% in 2016, primarily due to lower cigarettes sold and higher revenue driven by the company resorting to price increase per unit and higher heated tobacco sales. This decline from 77% to 76% has added about $450 million to the company’s profits, which translates into additional earnings of $0.29 per share. Excise and cost of sales is further expected to drop to about 74% of revenues by 2020, as cigarette volumes decline further and a large part of revenue growth would continue to be driven by price rise and phasing out of discounts. This drop from 76% in 2018 to 74% in 2020, is expected to lead to additional profit of over $1.9 billion, translating into incremental earnings of $1.27/share over the next two years on account of better management of excise and cost of sales. In our dashboard How Does Philip Morris Spend Its Money?, we discuss the trend in all major expense items and what is driving the change.

Total Expenses

Philip Morris’ total expenses have grown from $67.7 billion in 2016 to about $71.5 billion in 2018. For 2019, we expect total expenses to stand at $72.2 billion, which comprises of-

• Excise Duty: $50.1 billion
• Cost of Sales: $11.0 billion
• Operating Expenses: $8.0 billion
• Non-Operating Expense (Income): $0.6 billion
• Income Taxes: $2.5 billion

Philip Morris’ Net Income Margins decreased to 8.1% in 2017 due to a sharp rise in tax expense, as the company reported one-time transition tax before TCJ Act came into force. Margin increased to 10.4% in 2018 due to a lower tax rate and decrease in interest outgo. Net income margin is likely to continue to increase to 12% by 2020, led by higher revenues, lower excise tax as cigarette volume sales decline, and declining interest expense on the back of lower rates and deleveraging.

Breakdown of Philip Morris’ Total Expenses

Excise

• Excise tax has increased from $48.3 billion in 2016 to $50.2 billion in 2018, driven by continuous hike in excise tax on combustible tobacco products. It is expected to go further up to $50.5 billion by 2020.
• However, as a % of Revenues, Excise has steadily decreased from 64.4% in 2016 to 62.9% in 2018, as revenues grew at a faster rate and this revenue rise was driven by price increases per unit rather than volume growth.
• It is likely to go further down to 60.5% of revenues by 2020, as cigarette volumes continue to decline and revenue growth would come from higher pricing and heated tobacco.

Cost of Sales

• Cost of sales has increased from $9.4 billion in 2016 to $10.8 billion in 2018, driven by unfavorable volume mix and foreign exchange headwinds, along with a sharp rise in heated tobacco volume sold. It is expected to move up to $11.3 billion by 2020.
• As a % of revenue, cost of sales increased from 12.5% in 2016 to 13.5% in 2018, as the company continued to offer incentives/discounts on heated tobacco products, due to which revenue growth did not match up to volume growth.
• The metric is expected to remain flat at 13.5% in the near term with the gradual phasing out of discounts, and cost of sales and revenues, both seeing an upswing.

Marketing, Administration & Research Cost

• Marketing, Administration & Research (MAR) cost has continuously increased from $6.4 billion in 2016 to $7.5 billion in 2018, driven by increased investment behind heated tobacco products across all regions, predominantly the European Union and East Asia & Australia.
• This cost is expected to move further up to $8.3 billion by 2020, as the company is expected to push its heated tobacco offerings more aggressively, on the back of dropping cigarette demand and regulatory crackdown on e-cigarettes.
• As a % of revenue, MAR cost has increased from 8.5% in 2016 to 9.4% in 2018, and is expected to reach about 10% by 2020.

Non-Operating Expenses

• Philip Morris’ Non-Operating Expense has decreased from $885 million in 2016 to $646 million in 2018, driven by a drop in interest expense on the back of lower interest rates and debt repayment, along with a drop in employee-related pension costs.
• Going forward, interest cost would be the primary driver of non-operating expenses.
• To understand how Philip Morris’ non-operating expenses are expected to move in the near term, view our dashboard analysis.

Effective Tax Rate

• Philip Morris’ effective tax rate increased sharply from 28% in 2016 to 41% in 2017 due to the one-time transition tax recorded prior to the implementation of the TCJ Act.
• The rate dropped to about 23% in 2018 and in the near term it is expected to be around the same level, which would be slightly more than the US statutory tax rate, as it operates in various geographies.

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