Philip Morris International Inc. (NYSE:PM)
2013 Barclays Capital Back-to-School Consumer Conference Call
September 4, 2013 10:30 AM ET
Jacek Olczak – Chief Financial Officer
Okay, we’re going to get going with our next presentation. Our next speaker is Jacek Olczak, the Chief Financial Officer of Philip Morris International. Jacek joined Philip Morris International back in 1993 and assumed the Chief Financial Officer role just over a year ago, back in August 1, 2012 after having served for three years as the President of Philip Morris’ EU region.
While the external environment has certainly been challenging for global consumer packaged good companies, Philip Morris continues to expect double-digit currency-neutral EPS growth in 2013. We look forward to Jacek’s insights on the future of the global tobacco category and the opportunities and challenges in front of PM.
And with that, I’ll turn it over to Jacek.
Thank you, good morning. It’s a great pleasure for me to be back in Boston again, at the Barclays Back-to-School Consumer Conference and have the opportunity to talk to you about our business. I welcome those who are joining us on the webcast. My remarks contain forward-looking statements and accordingly, I direct your attention to the Forward-Looking and Cautionary Statements section of today’s presentations and our SEC filings. A glossary of terms is available on our website and is included in this presentation.
We are confident that we can deliver robust financial results in 2013. As you know, we have indicated that we expect a better second half of the year with a particularly strong fourth quarter. We will not be talking about the guidance today as we are approaching the end of the quarter. In line with our tradition, we will update our guidance during the next earnings call.
The total market environment continues to be exceptionally difficult, but we have seen some moderation in the negative industry trends in the EU region. Our brands continue to perform well and we have solid global market share trends. We are addressing issues in Japan and the Philippines, but these will take some time to show concrete results. Of key importance, our ability to price remains strong, and this will offset the volume softness.
Let me start with the EU region. In the EU region, while the level of unemployment remains high and cigarette industry volumes continue to decline at a significant pace in many markets, we have seen some moderations in the rate of decline. The trends of cigarette industry volume on a three-month moving basis through July were generally better than the year-to-date trends, with the most notable improvement in Germany. On a Regional basis, the decline was 6.6% over the last three months, compared to 8.4% year-to-date. While this is no cause for great optimism, it is in line with our expectations for a better second half volume trend.
We continue to register a good market share performance across the EU region. On a year-to-date basis through July, our Regional cigarette share was up by 0.7 points to 38.8%, while our fine cut share was 0.9 points higher at 14.5%. This was driven in particular by the strong performance of Marlboro, whose cigarette share rose by 0.5 points over the same period to 19.1%, and whose fine cut share was 0.9 points higher at 3.4%.
Let me complete my update on the EU region with a few words about the pending Tobacco Products Directive or TPD. The proposal made by the European Commission calls notably for a ban on slims and menthol cigarettes, 75% graphic health warnings and a pharma approach to e-cigarettes, though it does not mandate plain packaging. This proposal has been reviewed by various committees in the European Parliament and the Council of Ministers.
Diverse positions have emerged. For example, a number of Parliamentary committees have proposed a 50% warning size, the Council 65% and the Parliament Committee on the Environment, Public Health and Food Safety or ENVI, 75%. There is also a difference of opinion on slims with only ENVI supporting the EU Commission proposed ban.
The European Parliament is expected to debate the issues during the plenary session that starts on September 9. Whatever emerges will then be discussed as the part of the trilogue with the Council and the Commission in order to agree on a final legislative text. The TPD is expected to be adopted by the end of this year. Member States will then have a period of 18 to 24 months to transpose the TPD into the national legislation.
We believe that major provisions in the current draft fail to meet standards of sound, evidence-based policy and rationality, such as, for example, the ban of entire segments of the market and the excessive health warning. We will continue to argue for the elimination or moderation, respectively.
Let me now turn to two key markets in the EEMA Region, starting with Russia. Through the end of July, cigarette industry volume is estimated to have declined by about 7%. The decrease has been concentrated in the super-low price segment, whose volume declined by an estimated 17% during this period. This reflects the impact of proportionally higher price increases at the bottom of the market, slower economic growth, and the emergence of illicit alternatives. While still relatively low, illicit trade has increased compared to the previous year. In July, two successful anti-counterfeit raids were carried out in and around Moscow, and the Russian authorities are showing a greater awareness and a willingness to address this phenomenon.
We were ahead of competition in our implementation of price increases announced in December last year and June this year. Nevertheless, we were able to maintain a solid market share of 26.1% year-to-date July, down by just 0.1 point. This reflects our well-balanced portfolio led by Parliament in premium, Chesterfield and L&M in the mid and the Bond Street in the low-price segment, as well as our relatively low exposure to the super-low price segment.
Cigarette industry volume in Turkey declined by an estimated 10% year-to-date July due to the resurgence of illicit trade that reflects the government’s focus on other priorities in recent months. The key trends in the market continue to be adult smoker up-trading to mid and premium-priced products and the expansion of the super-low TRY 6 per pack price segment. This is at the expense of the low TRY 6.50 per pack price segment. The continued growth of Parliament in premium and Muratti in the mid-price segment has improved our mix.
However, this has not been sufficient to prevent a slight year-to-date July market share loss of 0.2 points to 45%, which is attributable to the decline of the low-price Lark and L&M due to the price sensitive adult consumers moving to the super-low price propositions. We have addressed our under-representation in the super-low price segment through the re-launch of Chesterfield in June and the initial results are promising. The brand achieved a 4% Nielsen market share of the super-low segment in July.
One of the highlights of the EEMA region is North Africa and the Middle East. Our year-to-date July estimated market share in North Africa grew by six points to 27%, behind the strong performance of Marlboro across the area and the growth of L&M in Egypt. Our North African volume grew by 30% during this period. We also maintained our clear leadership position in the GCC with an estimated 44% market share and a volume growth of some 3%.
Our market share in Japan in July was 26.5%, slightly above the previous month, but 1.3 points below the last year’s level, when we benefited from the pipelining of Marlboro Ice Blast 5 milligram and 1 milligram propositions. We have two key objectives in the Japanese market. We need to reinforce our leadership in the growing menthol segment and we have launched two new innovative menthol offerings; Lark Ice Mint, the first 100 millimeter capsule product in the mainstream segment, and Marlboro W-Burst, the first double capsule product. Consumer acceptance has been encouraging.
The second objective is to obtain a larger share of the non-menthol segment, which still accounts for nearly three quarters of the market. Our traditional brands in this segment, Lark and Philip Morris, are under pressure, resulting in a 0.7 segment share decline.
We have just launched a new smoother-tasting Marlboro line-up, called Marlboro Clear, to widen the appeal of the brand to mainstream non-menthol smokers and improve Marlboro’s relatively small 6% share of the segment. The new products provide adult smokers with a smooth taste and a clean aftertaste.
Innovation remains a key to success in Japan though our initiatives will take some time to bring about a recovery in the market share. Industry volume meanwhile remains on track with our forecast of a modest decline of about 2% for the full year. And finally, with regard to the foreseen increase in the consumption tax in April next year, we expect a final decision by the government during the fourth quarter.
Let me now turn to the Philippines. The positive news is that monthly average tax paid industry volume has been 8 billion units over the three months through July, representing a relatively modest decline of 5% compared to the same period last year. This is a significant improvement over the 5.1 billion unit monthly average volume during the first quarter of this year.
We believe that this improvement is predominantly attributable to a local competitor declaring a higher proportion of its volume for excise tax purposes. Adult smoking incidence is slightly above last year and average adult daily consumption has declined insignificantly. This indicates that overall consumption levels have not been significantly impacted so far by the huge disruptive excise tax increase that took place at the beginning of the year.
However, we have witnessed substantial adult consumer down-trading to the super-low price segment, where the stick price is still an attractive 1 Peso and where virtually all local competitors’ brands are positioned. As a result, the super-low segment has grown from 15% last year to 44% in the last three months through July. We strongly believe that the current 1 Peso per stick price level is economically unsustainable assuming full tax enforcement. Therefore, we would expect the market to eventually revert to more acceptable, historically-prevalent price gaps.
In the meantime, we have been seeking to incentivize the retailer to reduce the stick price of our key brand, Fortune through trade programs, have supported our own super-low price brands in order to protect our market share, and continue to work closely with the Bureau of Internal Revenue to obtain a level playing field. Full tax enforcement and the resulting reduced price gaps will be critical to the profitable recovery of our business in the Philippines going forward.
Let me finish my update of key markets with Indonesia. Due to the recent spike in inflation, we now forecast industry volume to grow by approximately 3% this year, in line with the historical average, though below the exceptional increases of 2011 and 2012.
Year-to-date July, our market share reached 36.2%, 1.1 point ahead of the prior year as the growth of Sampoerna A, Marlboro and U Mild more than offset a weaker performance of Dji Sam Soe. Dji Sam Soe has crossed the favorable 1,000 Rupiah per stick price point. We believe that, while we will hit road bumps on specific brands from time-to-time, due to price points and the importance of stick sales in Indonesia, attractive growth opportunities remain going forward.
The machine-made low tar, kretek segment continues to expand, albeit at a slightly more moderate pace, and we are making steady inroads into the full flavor machine-made segment. In the last two months, we have continued to increase prices on a regular basis, helping to drive margins higher following the January excise tax increase and the increase in the cost of cloves.
On a global basis, our pricing remains strong, backed by the strength of our broad portfolio and supported by a largely rational excise tax environment. We achieved a pricing variance of over $1 billion in the first half of this year, which is some $200 million more than during the same period last year.
We have achieved excellent market share performance this year, with gains year-to-date July in all four regions, excluding the Philippines. This should enable us along with our strong pricing to mitigate the continued globally weak cigarette industry volume, which remains a key challenge for the remainder of the year and into next year.
In addition to the solid prospects for our conventional business, let me also briefly share with you the important progresses we have made so far this year with the Next Generation, or Reduced-Risk, Products. We are on track with our two manufacturing facilities, with 2016 the target for completion. We have commenced five out of eight sets of full clinical studies with results expected in 2014 and we are carrying out full consumer acceptance tests for one product platform.
Early results are very positive with a high acceptance rate, taste liking and exclusive use. We thus remain on track to successfully launch Reduced-Risk Products in 2016, 2017, which will provide PMI with exciting new business opportunities.
In conclusion, our business fundamentals remain solid despite an exceptionally difficult economic environment that has encouraged adult smokers to switch to cheaper alternatives to tax paid cigarettes, such as fine cut in Europe and illicit trade in many markets.
We have a very good geographic balance with strength in both developed and emerging markets. We believe we have the best brand portfolio led by Marlboro and Parliament in premium and Chesterfield, L&M and Bond Street in lower price segments. The issue in Japan and the Philippines are known and will unfavorably impact our results this year, but we have strategies in place to address them.
We are confident that we’ll deliver strong financial results in 2013 and we continue to focus on returning cash to our shareholders through share repurchases and dividends, while seeking strategic investment opportunities that will strengthen our business. Finally, we remain very excited by the prospect for the future commercialization of our next-generation or reduced-risk products.
Thank you for your interest in the company. I will be happy to answer your questions now.
Jacek, Europe has clearly been a very challenging market for you and you highlighted that. Could you give us a sense of when you think we’ll be able to move back to a more historic rate of volume decline in that market, particularly in light of the TPD and the myriad of factors, what’s the timeline for a more normal environment?
I think that we have to go back to the key drivers behind the volume performance in the EU. And we know that once the government’s implemented the austerity measures, unemployment increased and we started seeing big pressure on the volumes, total industry volumes in the EU. Consumers were down-trading to fine cut because this was, and is still in some market, more attractive price wise proposition supported by lower taxes. I think this we are addressing. Overall, we are addressing a number of countries, so from a tax perspective, that leakage which we had from the manufactured cigarette is addressed.
Unemployment is just a factor of what happens in a macro economy. As you followed the report in the year, I mean, nevertheless, demand is not much of the – more of a bad news when it comes to unemployment, but we still don’t see this curve going up. I mean the unemployments are surely being reduced. Once we see this, also we expect that the EU rate of decline should moderate. I mean, well it won’t moderate in a very short period of time than the historical level and everything depends on the economic recovery. To results of that over the last few months, the results which we received from the EU in terms of the total market, also our performance, I mean, they – on a higher ends of our expectations.
So I see that there is something going on a positive side on a – on the volume side in the EU. What I built on this is a very positive outlook scenario for the next year, presumably needs a little bit of a automobile plan. But so far, the situation is definitely not getting worse if it’s not getting better. TPD, you mentioned, and you have to – we have to understand one thing, TPD will have the impact – depends a lot of impact, I mean, we shared the final TPDs to materialize I mean, that’s more in the midst of rise of the implementation dates and so on. So have to see what is the final forum is the final shareholder TPD and then we can start building some scenarios.
I think your annual guidance implies fourth quarter earnings growth of approximately 20%. Given the headwinds you’ve discussed, given the fact that it was a pretty good fourth quarter last year, could you just elaborate on the reasoning why you expect the fourth quarter to be so strong?
I think we covered this on the second quarter earnings call. I think there is a timing of our investments last year versus this year. So clearly, we’ll have a less pressure when it comes to the comps Q3, but very much also Q4, and we’re scaling up our investment last year. Because also some of the investments, which we are making this year very much in the Asian region, especially the market, which I mentioned in my presentation, i.e. Philippines, is of the – if you like of the variable nature. I mean, we had to very aggressively go and expand in order to support the share, the right price points, price gaps, and to not necessarily discuss the continuum until the year-end.
If you could just talk about pricing, which has obviously been a very key driver of your business performance. What are your thoughts about long-term pricing power for the company, particularly, have you envisioned a market like Russia developing, but perhaps a slightly different, more price focused strategy? And then in terms of Japan, what’s your longer time perspective about the pricing algorithm in a market like that?
Well, I feel – well, I mean, this year, we said that before the first half of the year $1 billion pricing variance is very solid, very robust pricing variance is ahead of what we used to have last year in the same period. Also if you look at historically over the last five years, the pricing variance, which Philip Morris was delivering were the high-end of this pricing variance. So we feel – I think we feel comfortable that the pricing remains very strong in the industry.
I think you also have to look at that from the perspective of our – how our business develops in, why we’re taking a pricing. There’s not only $1 billion of the pricing variance for the first half of the year, but a very solid share progression in a number of geographies, essentially, in all markets. Most of the markets, we’re building the share, despite the fact that very often we have fully in the pricing. So this is not the market share, which we’re building due to the aggressive pricing, is actually very attractive pricing from the bottom line perspective. Well, the brands are strong enough to maintain the market share.
Russia, I think I have said it on some previous occasions; Russia is approaching more mature stage when it comes to the tobacco market, to the cigarette market. Yes, there will be – they have scheduled the tax increases. What we have to remember is that Russia has started with a relatively low tax incidence. So the low versus the international developed a lot of averages. So there will be always a pressure on the tax increases. The art is or the trick is how to make this tax increases without destabilizing the markets very much, not waking up the illicit trade. But I think Russia is more of the value story going forward than a volume story. And I think there are – there’s a lot of opportunities for the growth to support PMI.
Japan is the only market, which is generally the market leader and I – we tried in a path to lead the price increase once, but I don’t think we are in a position to do it again. So there is a little bit difference there. Let’s see how the situation evolves around the consumption package increase and will this and how this will result for translating to the price increase in a market. But overall, we feel very positive, very positive when it comes to our ability to price. Especially, as I said, it’s a context that seems that our brands in most of the markets can take the price increases, not only we can defend the share, we can grow the share.
You are optimistic about the consumption tax and the ability then to translate that into further pricing?
And by nature, I’m an optimist, so.
Thank you. Two questions, first in the Philippines, as you prepare for the next round of excise tax decreases next year, do you have any indication that the competitors that have underreported are preparing to actually raise prices and how long are you willing to keep up these variable investments that you’ve implemented? Then the second question is, it feels like in tobacco, e-cigarettes have taken over the conversation at least in the investment world, you’re pursuing Platform 1, but you’ve seen your other competitors globally take step on e-cigarettes. Why not diversify whatever your efforts are and not put all your eggs in one basket?
On the Philippines, frankly speaking, is that competitor was to pay all taxes due according to the tax rate for this year, we think was economically unsustainable. So there is a tax increase, I mean, that’s becoming given, is putting even more pressure beyond already unacceptable pressure economically, which we have today. I think it all come to the law enforcement, and then achieving the level playing field is a key to success in Philippines, integrate the toughest situations which we have now, but as I indicated in my presentations, in my remarks, but as a fact declaration from the competitors are going up.
So hopefully, once you pay all taxes due, you will have to sooner or later reflect the final price to the consumer and this would support the price gap, but hopefully, we’ve had this sudden trade or down-trading there. So this maybe it’s going to happen already this year, because I don’t know, but there is a number of the factors which have to come to play together. When it comes to the cigarettes, I have – we have made – we have updated you where we progress on the Platform 1. You know that we have a few platforms in our portfolio.
One of these platforms is essentially cigarette and it is not that we’re giving up on e-cigarette, which is an upgrade of the Platform 1, which is the tobacco heated platform. And for us, is critical to have a clinical scientific assessment in order to be able to have a dialog with the regulators when it comes to the hard reduction et cetera to have a solid evidence. So we’re continuing our strategy and we are progressing as per our plan. But let me again remind you from out of the three platforms, one of the platforms is e-cigarette as well.
Considering broadly, can you just give an update on the outlook for excise taxes for 2014 and maybe talk about Japan and the Philippines. Are there other proposals proliferating in any of your major markets in terms of excise tax increases? And then just the second follow-up on the last question, how does the TPD’s proposal on e-cigarettes impact your investment decisions in terms of investing against these three platforms?
I think year-on-year, we’re getting better when it comes to what sort of an outlook we have on the tax laws going forward, and that’s very much due to the more and more governments are embarking in the longer-term tax plans rather than debate in the November, December just was the – rendered the resulting tax increase in January, and we have the visibility in the European markets, including Germany, we have the visibility in Russia. So the Russia tax increases are not coming as a surprise. we have the visibility also in Philippines, and with that visibility, we can start preparing our plans accordingly.
In general, I think disruptive tax increases, Philippines, okay, worse disruptive tax increase, most disruptive was the behavior of the one of the market participant. I feel very confident when it comes to tax structure, because it’s not only important element of the absolute tax increases, but the way in which the taxes are being increased. And as you presumably know, in most of the jurisdictions, the taxes, the governments are paying more attention to the specific component of the tax than [indiscernible] and it grossly supports the price gap management, it grossly supports reduction in the down trading. Governments also very closely looking into taxation of the fine cut, and the numerous example, when the fine cut taxation increased the higher rates that the manufacturer made cigarettes. So that four are the critical components; how we can go for the tax increases, how we can come back the business in an environment where the taxes obviously will be going up.
So the tax structures are in place, directionally, it goes in the right directions; the fine cut is being addressed. The other thing, which we have to manage is that we don’t – are confronted with disruptive level of the tax increases. Frankly speaking, over the last few years, you can count on – count with the one hand, how many disruptive tax increases we had. This is managed.
Second question about the investments.
Our investments on TPDs, sorry, I missed it. Okay, we have to see what is final form of TPD. I think we today with the three platforms, which we’re working on, one which is this heated tobacco platform and one of the platforms, which is essentially very close to the cigarette, I think one way or another, we should be in a position to be able to market the product.
The critical element is how you can market the product. I won’t be able to say, what is your marketing strategy behind, what is your go-to-market strategy behind that as well, but as I said, we made the progress. We are assessing the TPD, we – and at the same time, we made the progress with the two manufacturing sites in Europe. So somehow, we feel optimistic or positive about this development.
If the regulators are indifferent to two platforms, are you indifferent in Q2s one or the other or both?
i think the heated tobacco platforms are very attractive platforms. From a consumer’s acceptance level, the test which I mentioned which we made in one of the countries on an acceptance level was very positive. I mean, the acceptance, the conversion of consumers from the conventional cigarettes to the regular exclusive yields of that platform, was at the level, which would be comparable to two or three times higher, as you would have at the best launch in a conventional cigarette, just to give you dimension.
We innovate – I innovate in many markets, very much obviously, in the U.S. markets and some other markets. The e-cigarette enjoyed, the whole category enjoyed extremely high awareness by the 90% close to 100%. That awareness does not translate yet to the significant volume markets. Yes, there is a growth in a category here and there, but nothing which would correspond to properly building to the 100%, almost 100% awareness. And I think we all know that the critical issue is that acceptance of the product is a factor of how much consumers like the product and it delivers very much on this functional benefit, the functional benefit, which leads to satisfaction.
There is obviously element of a route to the market in a branding, but I think even the best branding cannot overcome a product deficiency. And for us, the focus from the very beginning in a strategy is get the product right. We know how to build the brands as we have it, but the most critical is get the product right. Get the product right from the consumer acceptance perspective, but also from the regulatory perspective. I mean, we need to have the robust sales behind us to prove that the product does offer a benefit to individual and hopefully, also to the public.
Price at retail, which platform has the better margin and can you compare that relationship?
And the test which we have conducted was at the price levels corresponding to the premium cigarette.
Heated versus the charger?
No, we tested the heated platform. If this is your question, sorry.
The two platforms are different.
No. We tested one platform, only the heated platform.
Okay. We’re going to stop there and head back to the break-out. Please join me in thanking Jacek again.
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