Philip Morris' Management Discusses Q3 2013 Results - Earnings Call Transcript

Oct.17.13 | About: Philip Morris (PM)

Philip Morris International, Inc. (NYSE:PM)

Q3 2013 Results Earnings Call

October 17, 2013 9:00 AM ET

Executives

Nick Rolli - Vice President, Investor Relations and Financial Communications

Jacek Olczak - Chief Financial Officer

Analysts

Judy Hong - Goldman Sachs

David Adelman - Morgan Stanley

Vivien Azer - Citi

Chris Growe - Stifel Nicolaus

Bonnie Herzog - Wells Fargo

Jon Leinster - UBS

Thilo Wrede - Jefferies

Michael Lavery - CLSA

Erik Bloomquist - Berenberg Bank

Ryan Oksenhendler - Bank of America

David Hayes - Nomura

Chris Burritt - Bloomberg News

Operator

Good day. And welcome to the Philip Morris International Third Quarter 2013 Earnings Conference Call. Today’s call is scheduled to last about one hour, including remarks by Philip Morris International management and the question-and-answer session. (Operator Instructions) Media representatives on the call will also be invited to ask questions at the conclusion of questions from the investment community.

I will now turn the call over to Mr. Nick Rolli, Vice President of Investor Relations and Financial Communications. Please go ahead, sir.

Nick Rolli

Welcome. Thank you for joining us. Earlier today, we issued a press release containing detailed information on our 2013 third quarter results. You may access the release on our website at www.pmi.com.

During our call, we will be talking about results for the third quarter 2013 and comparing them to the same period in 2012, unless otherwise stated. References to volumes are for PMI shipments, industry volume and market shares are the latest data available from a number of internal and external sources. Organic volume refers to volume excluding acquisitions. Net revenues exclude excise taxes.

Operating companies’ income or OCI is defined as operating income before general corporate expenses and the amortization of intangibles. You will find data tables showing adjustments to net revenues and OCI for currency, acquisitions, asset impairment, exit and other costs, free cash flow calculations, and adjustments to earnings per share, or EPS, as well as reconciliations to U.S. GAAP measures at the end of this presentation, which is also posted on our website.

Today’s remarks contain forward-looking statements and projections of future results. I direct your attention to the forward-looking and cautionary statements disclosure in today’s presentation and press release for a review of the various factors that could cause actual results to differ materially from projections or forward-looking statements.

It’s now my pleasure to introduce Jacek Olczak, our Chief Financial Officer. Jacek?

Jacek Olczak

Thank you, Nick, and welcome ladies and gentlemen. As anticipated, we achieved improved financial results in the third quarter compared to the first half of the year, despite the persistent severe macro-economic challenges and their extraordinary impact on industry volume, adjusted diluted EPS, excluding currency, increased by 10.9% in the quarter.

A key driver of our performance has been the strength of our brand portfolio, despite its strong premium skew in a weak economy. We have strong market share momentum in the majority of our main markets with the key exception of Japan and the Philippines, where the issues are known.

In the quarter, our market share increased in the EU, EEMA and Latin America and Canada regions, while the international share of Marlboro, excluding China and the Philippines increased to 9.3%.

Our quarterly share in Asia was impacted by the timing of our shipments in Pakistan, as well as the share losses in the Philippines. On a year-to-date September basis, our international share, excluding China and the Philippines is stable at 26.7%.

The second key driver has been pricing. During the third quarter, we achieved a pricing variance of $488 million, bringing our total pricing variance for 2013 to over $1.5 billion. This compares favorably to the $1.3 billion achieved during the same period in 2012 and significantly more than offset the $900 million in unfavorable volume mix.

In addition to the substantial amount of pricing taken at the beginning of the year we have increased prices in a number of markets since May. These include Argentina, Australia, France, Germany, Indonesia, Kazakhstan, Russia, Spain and Ukraine.

Strong pricing coupled with the timing of certain cost items enabled us to increase our adjusted OCI margin ex-currency between the first half and the third quarter of this year from 45.2% to 47.5% behind a strong expansion in the EU, EEMA and Latin America and Canada region.

We anticipate a strong fourth quarter. The adjustment to our reported diluted 2013 earnings per share guidance today reflects the impact of changes in exchange rate and estimated fourth quarter charge for restructuring and the cautious outlook regarding certain markets.

In July, we forecast a reported diluted EPS guidance for 2013 of $5.43 to $5.53. Today’s guidance includes an additional $0.02 in unfavorable currency at prevailing exchange rates for a total of $0.33 per share for the full year. This also includes approximately $0.03 per share for a fourth quarter charge related to the restructuring program that we announced at the end of last month and the $0.01 charge related to the American Tax Payer Relief Act of 2012, which we reported in the first quarter of 2013.

Our reported diluted EPS guidance for 2013 is now $5.35 to $5.40. Excluding currency and the aforementioned charges, this represents a growth rate of approximately 10% compared to our adjusted diluted EPS of $5.22 in 2012.

Let me now review a number of our key geographies starting with the EU region. While unemployment continued to rise throughout 2012 in the 28 EU member states, it has remained stable this year at an average rate of 10.9%. However, unemployment has continued to increase notably in France and Italy. Despite a continued weak macroeconomic environment, the rate of decline in cigarette industry volume has gradually moderated throughout the year.

After a decline of 10.6% and 8% respectively in the first and second quarters, cigarette industry volume in the EU region declined by 5.4% in the third quarter, helped by the reduction in the excise tax differential between the cigarette and fine cut in several Southern European countries and stabilization in the prevalence of illicit trade albeit at a high level.

For the full year, we are still expecting total cigarette industry volume to be down between 7% and 8% while fine cut industry volume should be up slightly. Going forward, we expect market declines to remain above historical level until European government successfully tackled the issue of unemployment and the illicit trade and consumer sentiment and purchasing power improved.

Our business fundamentals remained strong across the EU region. We have gained share so far this year in all of the six largest cigarette markets in the region, namely France, Germany, Italy, Poland, Spain and the U.K. In addition, we have successfully leveraged our cigarette brand in the fine cut category, gaining one share point year to date September on a regional basis to reach 14.4%. While our OCI, excluding currency remained below last year level through September, it increased by 5.4% in the third quarter and we expect an improvement in profitability in the fourth quarter.

Our four key brands Marlboro, L&M, Chesterfield and Philip Morris continued to perform well. They all gained cigarette market share in the EU region in the third quarter. During the quarter, the share of Marlboro was higher notably in Belgium, France, Greece, Italy, the Netherlands, Poland and Spain; a remarkable result in view of the economy while L&M was the fastest growing brand in the region as a whole in terms of market share.

I will complete my overview of the EU region with an update on the status of the Tobacco Product Directive. The European parliament debated the proposal last week and accepted several amendments. The parliament notably agrees to a 65% health warning rather than the proposed 75%; that flavored cigarettes, including menthol variants, should be prohibited after a transition period of five years following the transposition of the TPD; that slim cigarettes should continue to be allowed and that e-cigarettes would not be treated as medical devices but rather be more strictly regulated under the TPD with higher nicotine thresholds than originally foreseen.

We welcome these marginal improvements but regret that the European Parliament voted to ban an entire segment of the legal market, despite the inevitable increase in illicit trade that this will fuel. They have failed to provide a comprehensive framework for reduced harm products and have continued to include oversized health warnings without any apparent concern for property rights that the EU Charter protects and restrictions on pack formats.

Finally, the proposal still contains an unworkable and discriminatory anti-illicit trade solution, which adds complexity to the legitimate supply chain without addressing the core problem.

The next step is for the European Parliament, the Council of Ministers and the European Commission to reach a final consensus. While the timing remains uncertain, the TPD is expected to be adopted before the end of this year or during the first quarter of 2014.

There will then be a period of 18 to 24 months for the Directive to be transposed into national legislation at the Member State level, so that it may become effective across the EU by the end of 2015.

Let me now turn to the two key EEMA markets, starting with Russia. We implemented an additional price increase of 4 rubles per pack during the June-July period on most of our brands, thus enhancing unit margins.

Due to the higher prices, a deteriorating economic environment and the implementation in June of workplace smoking restrictions, there was an acceleration in the rate of cigarette industry volume decline in the third quarter to an estimated 9%, mainly impacting the super-low segment. For the full-year, we expect industry volume to be down by about 7% to 8%.

Our market share performance continues to be resilient, in spite of competitors again lagging our price increases this year. Our August year-to-date market share was 26.1%, down by 0.1 share point, with Parliament in particular performing very well in the above premium price segment.

Despite the lower volume, our strong pricing enabled us to increase our profitability ex-currency at a double-digit rate in the third quarter. In September, the Russian Duma approved the excise tax rates on cigarettes for the period 2014 through 2016. In line with expectations, the ad-valorem rate will increase from 8.0% to 8.5% next January, while the specific excise tax will increase from 550 to 800 rubles per thousand cigarettes.

The pass-on for Marlboro would be around eight rubles per pack or approximately 11%. The increase in the specific excise tax is 45% in 2014, while the increases in 2015 and 2016 are slated to be 20% to 25%.

In Turkey, cigarette industry volume declined by an estimated 5% in the third quarter. Illicit trade declined only marginally from the second quarter. For the full year, we are forecasting an industry volume decline of around 7% to 8%.

Our business fundamentals remain strong with sequential volume improvements. Our market share was up by 0.1 point in the quarter through August to 46.1%, with further gains from premium Parliament and at mid-price Muratti. Both Lark and L&M suffered some share erosion at the 6.50 Lira per pack price, due to the rapid emergence of a 6 Lira and below per pack segment.

This was partly offset by our successful launch of Chesterfield at 6 Lira. The brand achieved a 1.2% market share in August, just three months after its introduction.

Finally Asia, where I will start with the Philippines. Tax-paid industry volume in the third quarter declined at a rate of 6.7% to 23 billion units and this in line with the second-quarter trend and a significant improvement over the first quarter decline rate of nearly 40%.

However, Nielsen consumer uptake adult smoking incidence and adult daily consumption data indicate that cigarette consumption is essentially stable while down-trading has been significant. The difference can be explained by the huge under-declaration by our main local competitor. While it increases its tax declared volume from an average of 500 million units per month in the first quarter to 1.1 billion units in the second quarter and 1.4 billion units in August, we estimate that this represented less than half of the volume it showed during this period.

The retail price of its main brand Mighty has remained as one peso per cigarette. This is an economically unsustainable level when paying full taxes. We continue to work with the Bureau of Internal Revenue and Bureau of Customs in our government authorities to address this issue. During the third quarter, we started to reduce our pricing support behind fortune and especially our lowest price brand. As a result, our monthly volume declined and our share of the tax paid market drop from 82.5% in the second quarter to 77.2% in the third quarter. We will continue to statistically balance the volume and profitability equation, but until the authorities address the issue decisively, the Philippines will remain a significant challenge.

Let me now turn to Japan where cigarette industry volume was down by just over 1% in the third quarter and remains on track to decline by about 2% for the full year. We have Tokyo objectives in Japan to reinforce our leadership in the growing menthol segment and to improve our performance in the larger non-menthol segment. To address the latter, we launch a new smoother tasting Marlboro (inaudible) September.

This was to widen the feel of the brand to mainstream non-menthol adult smokers and improve Marlboro’s relatively small 6.2% share of this segment. We still accounted for 73.7% of the total market (inaudible) September. Our market share decreased by one point in the third quarter to 26.5% reflecting the impact of competitor’s launches in the second quarter on Marlboro’s menthol segment share and continued our switching from the more traditional (inaudible) and Philip Morris non-menthol volume. Marlboro’s market share of 12.2% was however in line with the previous quarter held by the launch of Marlboro clear.

This new (inaudible) strengthened our pipeline of consumer relevant innovative offers should enable us to gradually stabilize our market share in Japan. Our optimizes is backed by the gradual reduction in the quarter-to-quarter share decline during the year and positive preliminary adult consumer update data for September. Earlier this month, the Japanese government confirmed its intentions to raise the consumption tax from 5% to 8% in next April. The percent for Marlboro would be about ¥14 per pack. But keep in mind that any price increase in Japan requires approval from the Ministry of Finance.

Let me now turn to Indonesia where the economic slowdown and the increase in the cost of basic foods and fuel impacted the cigarette industry which grew by just 0.03% during the third quarter. As a result, we are now expecting full year industry volume growth to be about 2%. The pressure on consumer purchasing power has be most acute around the lower income strata resulting in 7.6% quarterly decline in cigarette volume in the low price segment while the premium at this price segments were PMI index grew by 3.5% and 1.4% respectively.

This development (inaudible) growing adult consumer preference for machine (inaudible) has enabled us to continue to grow share. Sampoerna A and U Mild gained 0.6 points and 0.9 points respectively in the quarter. In addition, Marlboro has strong momentum. It gained 0.5 point to reach a quarterly share of 5.4%. Meanwhile (inaudible) has lost share since it became the first major brand to move about the (inaudible) price point ahead of competitive brands. We have continued to increase prices on a regular basis and it has now fully offset the impact of the January export tax increase as well as higher clove cost.

Effective October 1, the government enacted an amended regulation that addresses the loophole whereby large manufacturers could spread their production volume across sister companies and benefit from lower excise tax rates. This will affect around 2% of our volume, while the impact will be much more significant for several of our competitors.

We await the government’s decision as to whether the regular annual excise tax increase will be eliminated in 2014 or at least moderated to take into account the anticipated imposition of a new regional tax of 10%.

Let me also say a few words about the exciting business development projects that we have recently completed. The purchase of the remaining 20% interest in our Mexican affiliate for $703 million closed in the third quarter.

This is a profitable 34 billion unit cigarette market, in which we achieved a 72.8% market share through September this year. Marlboro had a 51.7% share over the same period, one of the highest in the world. The acquisition is projected to be marginally accretive as of the fourth quarter this year.

The second deal that closed during the third quarter was the acquisition of a 49% stake in Arab Investors-TA for $625 million. Algeria is a profitable $30 billion unit cigarette market, in which we achieved an estimated 40% share this year through September, driven by Marlboro. This investment significantly enhances our prospects in this important North African market.

The agreement also opens the door to additional business opportunities in certain other North African and Middle Eastern markets, such as Egypt. The acquisition is projected to be accretive as of 2014.

Our free cash flow was up by 45.5%, excluding currency, in the third quarter due mainly to a reduction in working capital and higher net earnings. In September this year, our Board approved a 10.6% increase in our quarterly dividend, which now stands at $3.76 per share on an annualized basis. It has more than doubled since the $1.84 rate at the time of the spin. Our target dividend payout ratio remains 65%. This reflects our strong confidence in our business fundamentals and future prospects. Our dividend yield is currently around 4.4%.

We spent a further $1.5 billion on share repurchases in the third quarter and expect a similar level of expenditures in the fourth quarter. By year end, we will have spent about half of the $18 billion three-year program that was authorized by the Board in August 2012.

Since the spin through this September, we have repurchased 539 million shares, representing approximately 26% of our shares outstanding at that time at an average price of $60.02 per share. During this time, we have been able to sustain our very solid balance sheet and remain committed to maintaining our single-A credit rating.

In conclusion, our business fundamentals are solid and our commitment to reward our shareholders remains steadfast. Despite persistently difficult macroeconomic conditions, our third quarter results were in line with our expectations and we anticipate a strong fourth quarter. We have updated our guidance to reflect prevailing exchange rates and the fourth quarter restructuring charge, as well as a cautious outlook regarding certain markets.

Our 2013 reported diluted EPS guidance is $5.35 to $5.40 and represents a full year growth rate of approximately 10%, excluding currency and charges, compared to our 2012 adjusted diluted EPS of $5.22.

Thank you. I will now be happy to answer your questions.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) Our first question comes from the line of Judy Hong with Goldman Sachs. Please go ahead.

Judy Hong - Goldman Sachs

Thanks. Good morning.

Jacek Olczak

Good morning.

Judy Hong - Goldman Sachs

So, Jacek, I guess first question is, is just looking at the Asia region and I think at the corporate level the pricing variance was very strong, but within Asia, I think, sequentially the pricing variance actually decelerated. So, I’m wondering if you can just give us some perspective of how much pricing you've taken in Indonesia, what was the timing of that and then how much of that was offset by the Philippines lowering other price and how we should think about that in the fourth the quarter? Is this something that we'll continue to drive down to fourth quarter or is it the timing of the Indonesia pricing such that pricing actually accelerates in the fourth quarter and does that help your margins in Asia?

Jacek Olczak

It might just (inaudible) could give you some color. I mean, Asia, if I exclude Philippines, Asia margin for the quarter essentially would be flat so the Philippines is driving the margin performance in Asia in the quarter. Pricing wise, I mean, Indonesia is going as per planned, as you know we have a regular pretty often I should say as the price increases there. And as we said on the second quarter call around this time of the year, we should offset the pressure from offset the impact excise tax and clock prices.

So Indonesia now is in a positive territory when it comes to margin improved that should remain like this for the remaining fourth quarter. One thing which we have to remember which we don't have in Asia is that lack of pricing in Japan, right. So that is something which just appears from time to time.

Judy Hong - Goldman Sachs

Okay. And then just following up in Indonesia can you just give us your thoughts on the likelihood of the new website tax going in Indonesia next year and then just in light of the magnitude of the potential excise tax can increase if all of that goes through next year, how you are thinking about kind of the volume outlook as we go into 2014 and your ability to pats on the pricing in Indonesia.

Jacek Olczak

Well, I mean, pricing Indonesia remain strong for this and in the previous year, so despite the tax increases and also the price on the input cost, but I mean, I don't see today anything on a horizon which were to put that question mark on our ability to price in Indonesia. So pricing remains strong in Indonesia. What we know at this stage is that there will be local tax of 10% increase to the current rate under the question is our national government will like to put something on the top of that and (inaudible). I think at this stage, I think it's more of a speculation. I'm we'll know for sure what is the tax for Indonesia by the end of November, that is on a pricing in Indonesia.

Judy Hong - Goldman Sachs

I mean, last question (inaudible) just looking at the volume decline obviously in EEMA and Ukraine, first just in terms of the outlook for those market, you've kind of given the rest of this year, but is this illicit trade situation really a problem that you think will continue to impact as we get into 2014 and then I think there are some charter about the government potential looking at reversing excise tax increases or were there plans to reverse the excise tax increases, unless we are given the illicit trade ramp up, so I'm just wondering if you have any thoughts on that prospect?

Jacek Olczak

Hi (inaudible) there is more of these show really situated in Ukraine than in Russia. In Russia, we started of serving some incidents, I think of about 3% as of second quarter in Russia. I think it stays about the level that actually is better reason for Prime Minister being interviewed in which we think that might be the issue to looking to the tax rate, growth of the tax rate in the three year plan. For a time being, what we know is that the tax will be the specific component and a little bit of that will go up in January next year; this will create a pass on or for the pass on the (inaudible). And then if you follow the three year plan, the remaining three year the platform should be 5 and 8, so 5 in 2015 and 8 in 2016.

So for me it might be pretty much a speculation today, but I think they are more refers to the tax increase in the last year of the three year plan and on the third year of the plan. We are also watching, I think it's a very welcome by art, I mean, Russian government started watching how their prices is compared to the surrounding conflicts, which we know also plays the factor in any incentive, if you like really sits straight. So now as long as a Russian government on alert and they try to think proactively, I mean we very much welcome this development.

Judy Hong - Goldman Sachs

Okay. Got it. Thank you.

Operator

Your next question comes from the line of David Adelman with Morgan Stanley.

David Adelman - Morgan Stanley

Hi, Jacek.

Jacek Olczak

Hi David.

David Adelman - Morgan Stanley

Couple of questions. First of all, Jacek, what’s the prospect that in trying to manage the business in what’s clearly a difficult macro and difficult volume environment that you feel that in retrospect, six months from now, nine months from now, that you haven’t done sufficient -- either sufficient marketing in certain of the markets or that maybe that you in retrospect will push pricing a bit too hard?

Jacek Olczak

No. My spent behind the brands is, I mean, for the total year, my spent will be above the last year’s level. I mean, we -- I know that we have some comps -- various competitions this year, I mean, quarters-on-quarters, but over -- for the full year, we will actually invest more than the last year. And as you will see also from our brand portfolio perspective, I mean if the brands wouldn’t grow market share we would -- if they would be lacking any investment.

So I think we are doing right job is the deployment in the commercial organization, the number of innovations which we are bringing behind the Marlboro and all other brands, I think that -- the brand portfolio in terms of the equity, the help of the brands I think might be a strongest year we ever had since the spin of how the portfolio performs.

Now you mentioned the macros which we had, there are macros in a country. They are not macros on a global basis. So we need to start looking into this a little bit more selectively because, yes, there was a bit of acceleration in Russia for the wrong reasons. Yes, we have a big challenge in -- major challenge in Philippines, but we also have a markets frankly speaking where the total industrial volumes are growing and there is uptrading. So I would be very careful, how we talk about the thing, the macro does not necessarily mean global.

David Adelman - Morgan Stanley

Okay. Second question, Jacek, presumably your budgeting is not done for next year, you don’t know all of the excise tax increases that you would necessarily face and I am not asking for a specific prediction? But broadly speaking what’s your confidence level today looking out to next year that the company can deliver financial results that are consistent with the mid-to long-term plans that you have?

Jacek Olczak

Well, it is pretty challenging this year as many have noticed and we still have, in our guidance today, we said that we are going to deliver approximate 10% growth. So and we have the number. We had a number of challenges this year. Some of them may fade out, some of this may continue next year.

I think, when I feel strong, when I feel confident is, the number of quarters which we demonstrated the dollar brands are very strong, including Marlboro despite the adverse microeconomic in some countries, especially European Union.

Pricing power, I mean, you have seen our pricing power for the first three quarters of this year is $1.5 billion, I mean, that is very strong and that remains and I don’t see anything on the horizon, which could challenge this one. I think a tax structure is applying into our hand and frankly speaking, at this stage we are not aware, we don’t feel that there was any attempt to have a disruptive tax increase in the near future.

So, there are a number of factors which plays into our hand. Total markets are priced driven by various factors in some geographies may continue through the 2014. I mean this we’ll have to see.

I mean you notice that EU is getting sequentially better and better, but I don’t see under like data which would give me more opportunities. I am referring to unemployment, because employment is spread like pancakes since January this year, although the industry volumes development is encouraged. But, I think, I need another quarter or so, and then we will be more confident to say more firmly how do we expect our performance for ‘14 and beyond.

David Adelman - Morgan Stanley

Okay. Thank you very much.

Jacek Olczak

Thank you.

Operator

Your next question comes from the line of Vivien Azer with Citi.

Vivien Azer - Citi

Hi. Good morning.

Jacek Olczak

Good morning, Vivien.

Vivien Azer - Citi

I wanted to touch on price elasticities globally given some of the buy downs that you have seen across some of your major market and Indonesia really comes to mind. I am curious, I appreciate that inflation is becoming a bigger and bigger issue, but have you noticed the deterioration in your price elasticity as well?

Jacek Olczak

No. I think on a global basis, where the elasticities are between minus 0.3 to minus 0.5. This is -- and in some countries you will see the higher elasticities but they are driven by the fact that the consumers disposable income is on the negative side, right. So in the real terms, our price increases may trigger the higher elasticity. I think Italy, Spain and a couple of the Southern European countries, they presume (inaudible) in a heightened elasticity levels just because there was an erosion on the disposable income. Indonesia, as you referred to, I don’t think we have the (inaudible) would be fairly in the range which I gave at the beginning.

Vivien Azer - Citi

So for Indonesia, I mean it’s the third guide down in terms of your outlook for volume growth in that market in roughly four months. So in your mind then it’s strictly that inflation has just gotten that much worse that quickly?

Jacek Olczak

(Inaudible) have a different (inaudible) inflation and the food inflation and I think the food inflation impacts more in relative terms, some of the consumer growth, therefore, we see the volumes in the lower part of the market actually declining and the volumes in the premium segment going up to make the total market growing. I think you will have a different elasticity defined on the -- again on a disposable income of consumer. I think the underlying grade for Indonesia, the growth rate for Indonesia for the summer December in the range of … maybe about 2%. I mean this (inaudible) from the demographic and some positive GDP per capital -- develop.

Vivien Azer - Citi

Okay, thank you very much.

Operator

Your next question comes from the line of Chris Growe with Stifel Nicolaus.

Chris Growe - Stifel Nicolaus

Hi, good morning Jacek.

Jacek Olczak

Good morning, Chris.

Chris Growe - Stifel Nicolaus

Good morning. So I just have a couple of questions for you. I wonder as first of all to Philippines, it sounds like there has been some sequential improvement in tax collection there. You gave some number on that which is great. And so if you have any color on that and basically what's going on in the market? My following question for that would be the tax increase goes -- there’s a tax increase in the Philippines next year as well. It’s more heavily focused on the low end. If they’re going to see something like that to help move those low end prices up, was there enough that government can do in this (inaudible) to get more tax collection among these low price brands?

Jacek Olczak

Yes. That’s true that there was an increase in sequential tax collection. But you know the vision in Philippines is not about the colleting more taxes, but collecting the right amount of taxes. If somebody is paying more, but they’re still under declaring, frankly speaking of a little hedge, so the same sort of a tax evasion or cheating or whatever is the appropriate word for the situation. Now there is a tax increase next year. I think partially also why we are now moving with the prices up is to (inaudible) in the lower prices at the bottom of the market and waiting for the government to take the actions there, the government was immune by the fact that I was paying the taxes on a lower price portfolio. One of my competitors was not paying.

So I think partially as going with the prices, they’re bringing the government into the play because somebody is going to also suffer by not collecting the taxes. So we see how those (inaudible). I mean Philippines remains challenging. But situations might change in Philippines. The government is really decisive and its Law Enforcement Act, enforcement authorities are decisive. They can fix the problem in a month. But we have to wait for this month.

Chris Growe - Stifel Nicolaus

Okay. And I had just one more question for you, just sort of a broad question. You had a set of investments in several key markets that started last year. You’ve now wrapped a lot of those investments. I guess as we see softer volumes, is that indication that the investments weren’t enough that you need to invest some more? I’m just trying to look ahead and think about what you can do to help spend some of the declines in volume, is it something you can do from an investment standpoint more about the total market decline?

Jacek Olczak

No, I see the softening of my market share as the market shares decline. I think it would be an indicator for me that I am underinvested with regards to that support. My investment, marketing sales investment et cetera, I mean in cannot mitigate the impact of the total market decline especially that in some countries I am competing with illicit products. I mean that’s not a function of the marketing investment (inaudible). As I said with the earlier question, this year we’re going to spend more than last year (inaudible) in the quarters. But the market share advancement of all of our brands, most of our brands including Marlboro in a number of the geographies, I mean it’s the best testimony that we’re doing the right thing and we’re supporting the brands in the right way.

Chris Growe - Stifel Nicolaus

Okay, thank you for your answer Jacek.

Jacek Olczak

Thank you.

Operator

Your next question comes from the line of Bonnie Herzog with Wells Fargo.

Bonnie Herzog - Wells Fargo

Good morning.

Jacek Olczak

Hi, Bonnie.

Bonnie Herzog - Wells Fargo

I guess I’m still trying to understand how realistic your 10% EPS guidance is, given what this implies for volume growth in Q4. In other words, I think your volume growth needs to be positive in the quarter with pretty strong pricing to get close to your revised 10% EPS guidance. So how realistic is that for you to generate positive volume growth and then, I guess what gives you the confidence that this is achievable?

Jacek Olczak

Well, my total volume outlook for this year -- the total PMI’s volume outlook for this year is about in a range which we will have now for the nine months. So I think it is about 3%, ex-Philipines there is about our volume outlook. Pricing will continue as you’ll see quarter after quarter, we’re delivering strong pricing.

There were some prices which were into some places, we’ll implement the pricing in the third quarter. So that will have a full benefit in the forth quarter plus as we said that the earlier -- at the Q2 call, we’ll have some better comps on the cost side. So I feel very confident that we will deliver the forth quarter.

Although we’re fully aware that the fourth quarter growth rate will be significantly higher than what we had demonstrated in the third quarter. But this is all going as per plan as you remember I have started from the beginning of the year was that we’ll have a low start over the year and in the second part of the year, third and the forth quarter, this is where we expect to deliver the growth of this whole year.

Bonnie Herzog - Wells Fargo

So everything’s falling in mind relative to your expectation?

Jacek Olczak

Yes.

Bonnie Herzog - Wells Fargo

Okay. And I guess just my final question, I think is, the EU Directive decided not to ban e-cigs as medicine. So I’m curious, how does this change your thinking on the category and your timing for entering, if at all?

Jacek Olczak

Well, I mean, we -- you know about our plan, right that we said that we are working on three platforms and we’ve showed that we aim to 216, 217 for this whole commercialization. I think we stay on track with this one. I mean the directive -- what we’re missing in the directive is a little bit more time spend -- just later and trying to figure out what the frame work legislation should be for us meeting new product being e-cigarettes or others, new generation products that modified to risk tobacco product into the market.

The lot of focus was to spend on some other elements which I don’t think addressing really public health council which directive was suppose to authorize that the whole novel product territories are not fully addressed. But, yes, I mean if a good development that the e-cigarettes will be in the tobacco product directive rather than under the farmer’s legislation, we will see.

Also the other reasons I can’t talk where we would enter the market and how we could accelerate our entrance to the market, but we are very excited about this category working on our plan on -- we’re making a progress in accordance with the critical part delivering the clinical status. We are searching the consumers and organizing our -- building our capacity to be on time of -- everything goes okay maybe ahead of time with the products in the market.

Bonnie Herzog - Wells Fargo

Okay. That’s helpful. Thank you.

Jacek Olczak

Thank you.

Operator

Your next question comes from the line of Jon Leinster with UBS.

Jon Leinster - UBS

Morning gentlemen. I’ve got a few questions actually. According to me, the market volume guidance was 2% for the full year seems to imply as to 3% to 4% in the last quarter, I mean, is there any reasons, the industry volume should improve quite rapidly in the forth quarter after relatively weak third quarter?

And secondly, the Italy was quite a major -- market volumes down 4% in the third quarter. So quite a significant improvement than what we’ve seen in the past. Is there some particular fact behind that and do you expect that to be sustained with recent sort of that increases. Is that -- is that likely to deteriorate again?

Jacek Olczak

Okay. I may start with Italy. I may Italy -- yes it has had some improvements in the decline rate of the total industry volumes. I think what we have said also in Italy is a little bit of less of illicit product and I think it also partially might have contributed to the better results in the quarter. We will have to see what -- how that thing, how the lower incident of illicit product versus the beginning of the year, as you remember, I think they had spike to 11%. This lower illicit incidents, I don’t know how long it’s going to stay. So that may support the volumes. I mean as the VAT increase, I mean, it's an average sort of government trying to impose some extra taxes and are hoping for the better consumption. So that's a little bit not very welcome, but let's see how does it unfolds in Italy.

In Indonesia, I think there are some seasonality also behind the quarters and I think this is what drive us to believe that we will have a Indonesia will deliver on above the 2% for the full year and are little bit calls for the better or stronger volume performance in the fourth quarter of this year.

Jon Leinster - UBS

Thank. Then, we just going back to the Philippines, you are low with prices; I'm just going to get the timeline right. So you are low with prices in Q2 and then what that's appeared in Q3, did you actually sort of increased them again?

Jacek Olczak

We lowered prices, actually we start lowering the prices at the end of Q1. We were in full fledge in the Q2 and I think towards the end of the Q3, we started moving the prices up.

Jon Leinster - UBS

So certainly in the end of Q3 you started raising them. So in spite with the price reductions really didn't help at all in terms of market share.

Jacek Olczak

There was a down trading.

Jon Leinster - UBS

Yeah. Yeah. Okay. Thank you very much.

Jacek Olczak

Thank you.

Operator

Your next question comes from the line of Thilo Wrede with Jefferies.

Thilo Wrede - Jefferies

I saw that German course have spent the use of it (inaudible) campaign in Germany, how does it impact your business?

Jacek Olczak

They've banned some execution aspect of that campaign. But now considering you know that's available to our (inaudible) it's how we're going to go forward because we are pretty confident that we have not violated in local legislation. I don't think -- you know that the other forms of the market going to support to brand which we can continue delivering there because they are just questioning some aspect of that campaign. So I don't think we'll have a -- we should have any negative input of a suspension of this executional element of this company.

Thilo Wrede - Jefferies

Any concerns that other European cords will pick the same line of argument?

Jacek Olczak

Well, I mean, Germany is one of the few if not the only one country in the year which still allows you to bill board right, so they were questioning the bill board and so I think (inaudible) commercial in was with the other European countries the campaign is being delivered to consumers more for the one to one and other means. So no I don't think have any repercussion in the remaining European countries.

Thilo Wrede - Jefferies

And then I've also seen reports out of Australia, the convenience stores are now reporting an increase in illicit trade after the standard packaging and all that went into effect at the beginning of the year, are you seeing the same thing?

Jacek Olczak

We are seeing the same thing. I don't have the hard data, but the early information which we received from our obsolete in Australia indicates that there was about illicit traded about doubled versus what it used to be before the implementation of (inaudible) on illicit trade, but I'm not extremely surprised by this, because we taught that the play impact may facilitate the illicit trade and fortunately this is happening.

Thilo Wrede - Jefferies

Do you think that the fact that, the data is now starting to come out and make the legal challenge easier?

Jacek Olczak

Well, sorry the data will -- I think on the illicit trade will come out soon, once it's started out to confirm. I mean, this speculation -- I mean we've -- when it comes to our claim under the VAT, VAT in Hong Kong, I mean, that we are progressing there as per the calendar, but yes I mean, there is enough element which we have been raising with the government before the playing packaging is not addressing consumption frankly speaking, it will not get the total volume developments in Australia. You don't see any declines in total volumes as you have the appear of the, heightened appearance of illicit trade and I think also you might say that you see some acceleration in the down trading. This is all as we were saying this will be the impact of a playing packing.

Thilo Wrede - Jefferies

Okay. Thanks. (Inaudible)

Jacek Olczak

Okay

Operator

Your next question comes from the line of Michael Lavery with CLSA

Michael Lavery - CLSA

Hello. Just back on the Indonesia for a second. Obviously the inflationary pressures are some of what’s slowing category growth, but it also was the easiest comp of the year in the third quarter? What did it look like sequentially, was there improvement coming out of the quarter, I guess I want to understand a little better where the strength would come in 4Q, because that was one of the toughest comps last year as well?

Jacek Olczak

Well, usually, I think, the first quarter in the Asia was the strong quarter, that is what I was referring that there is some seasonality impact et cetera which you have in Indonesia. So, therefore, yes, we expect the stronger quarter this year.

As I said earlier, I don’t think that the growth rate of the industry in the third quarter is underlying growth rate of the industry, right. I think the underlying growth rate is a closer to 2%, about 2%]. So, yes, you will have the fluctuations between a quarter.

Michael Lavery - CLSA

No. I understand that, I guess, but the two things I am trying to get out is, if there’s seasonality, but it’s -- a stronger growth rate in the fourth quarter, does that give more and more exaggerated every year?

And then just back to the third quarter, can -- do you have any visibility on what the progression was throughout the quarter, was it same down in July and then flat in August, and up whatever percent in September that you can see the consumers adjusting to the inflation pressure that some of that momentum should continue into 4Q?

Jacek Olczak

Well, consumer are adjusting to that inflation pressures, I would just say earlier, I mean, you have a different rate, sorry, different impact by consumer income classes, okay. So if you have a second, I think it was second spike in a food inflation this year, one was at the beginning of the year, one was in the third quarter, well this has an impact on the consumption levels in the lower price classes, presumably more on the daily consumptions of smoking incidence, but this is what we have serve. So there will be adjustments in this -- in the consumer pattern. So that’s of -- that is on the volume side, this will happen.

Michael Lavery - CLSA

Okay. And then just on Japan for a moment, you reminded us that the Ministry of Finance needs to approve the price increases, which is of course true? Are you worried about getting that approve at all or you -- was that just stating that term kind of highlight the procedures involved?

Jacek Olczak

The role in Japan that if you want to change the prices, you have to seek the approval of the Minister of Finance, so that’s going to stay, also some Prime Minister and others have publicly, I think, before when the discussion was about the sales tax that talking about the fact that it wouldn’t like necessary to spike inflations while having the sales tax increase. So we will have to see. We have not filed for the tax -- for the, excuse me, for the price registration in Japan and there is still a time before the sales tax is implemented.

Michael Lavery - CLSA

Okay. Thanks. And then, I just want to make sure I have one clarification earlier in the call but as you said you expect profitability improvement in 4Q, was that versus 3Q '13 or versus 4Q ’12?

Jacek Olczak

I was referring to the growth rate of the EPS ex-currency in the fourth quarter over fourth quarter.

Michael Lavery - CLSA

Okay. And then just lastly following upon e-cigarettes, I understand you have your next-generation products that you’re developing and the EU TPD doesn’t really directly involve I think I don’t believe? But just in terms of e-cigarettes and then having what’s impact maybe little bit more of a Regulatory Green Light? At what point do you consider that a threat enough if those keep growing that you would want maybe getting involved in something on earlier timeline than your NPGs with, something like in e-cigarette, is there a launch you would consider, obviously you’ve got the U.S. market where the big three are getting involved and Lorillard is coming to the U.K.? Do you think that’s a place that you want to play or you intend to just wait for the next-generation products that you have coming?

Jacek Olczak

I’d said we are very closely watching the developments in the category. I think between the reasons why we said earlier that we’re working on the three platforms and one of the platform is essentially in the territory of e-cigarette, is that we believe there will be a reason there will be a market for all three platforms. Now the question still remains and if you look at the performance of e-cigarette category, a lot of attention is more on the marketing side side and to our knowledge, that the tension is on the product side. I think what is extremely important is in our (inaudible) strategy is to get to the product right. So I don’t think -- I’ve said it on a number of occasions, it’s not that you need to be first to the market, you need to go to the market with the right product.

Michael Lavery - CLSA

Okay. Thank you very much.

Operator

Your next question comes from the line of Erik Bloomquist with Berenberg.

Erik Bloomquist - Berenberg Bank

Hello. I was hoping you could comment on Russia in particular and why the premium shipment volume was down so severely in the third quarter (inaudible) were down 17%. That seems a bit odd with what's been relatively stable to rising trend for the mid to higher price segments. So I was wondering if something had been going on there that would explain that as an aberration or is that something that we should be considering as something that could have some continuing effects?

Jacek Olczak

The difference between our shipments to the distributor versus what is happening in the market, so the companies would (inaudible) these issues. Now if you look at the total market size in Russia maybe to give you a more color on this one, I mean the market was down about 7.9% if I remember correctly, for the quarter. If you look at the composition of the decline about, up to 17% of the decline came from the low price segment, but the value went about -- the value (inaudible) in a premium segment, they declined by a little bit by less than 3.5%. That’s 3.3%. So you could see that, the (inaudible) segments in Russia are doing relatively well. This price impacted the (inaudible) price increases and the lower segments have the more ease under more pressure.

But again I think it has been the same explanation to the use for Indonesia. I mean a different consumer growth that impacted differently by the price increases.

Operator

Your next question comes from the line of Ryan Oksenhendler with Bank of America.

Ryan Oksenhendler - Bank of America

Hey, good morning, Jacek.

Jacek Olczak

Good morning.

Ryan Oksenhendler - Bank of America

I just had a question regarding Japan in terms of the pricing that you would consider taking; have you thought about I guess which brand may get which level of pricing? I think you mentioned that it’s ¥14 per pack. But I think you want to probably increase it in ¥10 increments. How much -- is there a focus on maybe your price gaps versus (inaudible) and which brands will get what level of pricing?

Jacek Olczak

(Inaudible) we have decided our pricing strategy and I think it wouldn’t be appropriate for me to comment further on this at this time.

Ryan Oksenhendler - Bank of America

Okay. And then just regarding the illicit trade that you’re seeing in certain countries like -- Turkey you said, it’s still pretty bad, maybe you’ve got a little better sequentially. Ukraine and Russia are still also pretty bad. Does it have to get worse maybe before the government really steps in there and it actually starts to get better?

Jacek Olczak

No, actually I mentioned earlier (inaudible) referring also to some incidents, higher incidents of illicit product, tobacco illicit products and I think alcohol and that the government is considering now the option how to tackle the problem at the early stages is very welcomed. I wish many other governments would act so promptly when the problem is small rather than let the problem to grow to the almost, in some places difficult to manage the levels.

Ukraine is a little bit of a different story. Ukraine is also the story of the counterfeit products, not only illicit product. So every country has its own sort of the background in that. Turkey, sequential there was a slight improvement. We know from the part of the Turkish government, was highly very decisive and acted very promptly to address the issue which they can repeat more of the same. So let’s wait.

Ryan Oksenhendler - Bank of America

Okay, thanks for that and just my last question. Is it possible to get some insight in terms of what the FX impact would be overflowing to fiscal ’14? I think you’re (inaudible) some yen hedges as well as, can you give me -- give us some magnitude of what you see in fiscal ’14?

Jacek Olczak

Some of this -- everything depends on what's going to happen with the U.S. dollar. So that’s -- lot of surprises also coming from the U.S. side. I think yen may stay. Remember that we have hedged quite a portion of the yen exposure for this year early -- earlier. So I mean some of the pressure from a yen for us in terms of effective exchange rates, it will may continue to next year, depend where the yen is going to look.

Our issue is when we will revise the forecast now -- guidance now is essentially not because of yen is very much because of developing currency -- developing countries currencies. So I think Indonesian rupiah was the biggest driver of our revised currency guidance -- variance guidance.

Ryan Oksenhendler - Bank of America

All right, guys. Thank you very much.

Operator

Your next question comes from line of David Hayes with Nomura.

David Hayes - Nomura

All right, gentlemen. Hi. Just in terms of coming back to the underlying EPS cuts since the second quarter. You’ve obviously called out Russia is little bit worse since then, Indonesia as well, Turkey looks a little bit better, EU about the same. I just wonder whether there is anything else outside of those markets, it was driving that slightly low underlying EPS outlook that we haven’t spoken out.

And then I guess related to that in terms of the Russian side of things. You mentioned in the second quarter stage despite the volumes down more than you expected, you still saw profitability, you said explicitly the profitability will be up year-on-year, on the slide it wasn’t there this time. I just wonder you can confirm that you still see profitability in Russia itself being up for the full year? Thanks very much.

Jacek Olczak

Yeah. Yeah. I mean we see the profitability in Russia being very strong year-on-year as we demonstrated in this quarter. In terms of the countries or the market reach, we referring now at the guidance. I think, yeah, it’s Philippines which is on the list. In the Japan share of market since we had, okay, sequentially, we’re still seeing stabilization in Japan, but yeah we lost that one share point, one full share point on a quarter.

The Indonesia total market is softer in terms of the growth rate that we initially thought for the full year, so we’ll have to acknowledge that one. That’s about it. I think the main drivers.

David Hayes - Nomura

Okay. Thank you.

Jacek Olczak

Thank you.

Operator

Your final question comes from the line of Chris Burritt with Bloomberg News.

Chris Burritt - Bloomberg News

Thank you for taking my questions, Jacek. First, I wanted to ask about…

Jacek Olczak

My pleasure.

Chris Burritt - Bloomberg News

… in light of your recent success in Thailand and postponing the placement of those big health warnings on packages. What’s your -- what’s PM’s outlook for regulatory efforts in emerging markets? Which markets do you see your biggest threats on that front?

Jacek Olczak

Frankly speaking, it is not much that we cover more news on the regulatory front because, yes, I mean, the TPD, the regulatory developments which we’ll have to wait, there’s still a few months until we see what is the final conclusion on this one. And yes, I mean here and there you might have some regulatory initiatives but nothing actually on the horizon which would not allow me to sleep at this stage.

Chris Burritt - Bloomberg News

Okay. And if I may ask one last quick question, a bit of an oddball, given the rise in the popularity of electronic cigarettes hear in the U.S., what’s the policy for PM in terms of employees in your New York office consuming e-cigs. Is that always been allowed to something you’re allowing now given the popularity, what are you guys doing with that?

Jacek Olczak

Well, our New York office is a non-smoking office. This is for the convention of cigarettes. I know myself that presumably you will see me on number of occasions and I’m smoking my NGP. I think we would have to -- it's much more to that element of how disturbing you’re actually for others around you. It’s more of the matter of a heart disease than defining in the policy.

Chris Burritt - Bloomberg News

Thanks for your time. I appreciate it.

Jacek Olczak

Thank you.

Operator

That was our final question. Now, I’d like to turn the floor back over to Nick Rolli for any closing remarks.

Nick Rolli

Thank you very much. That concludes our call for today. If you have any follow-up questions, please contact the investor relations team here in Switzerland. Again thank you for joining us and have a great day.

Operator

Thank you. This concludes today’s conference call. You may now disconnect.

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