Philip Morris: Should You Buy It?

| About: Philip Morris (PM)


Last quarter Philip Morris was hurt by declining volumes and cost increases which led to both sales and earnings declines.

Moving production to a more favorable environment should bring in cost optimization.

The acquisition of Nicocigs provides the company with the expertise it needs to develop future products along with a significant portion of the UK market.

The future introduction of iQOS and HeatSticks should bring in volumes.

Philip Morris' (NYSE:PM) share value has fallen a little more than 5% in one year. However, it has picked up an upward trail since the beginning of February. When the company cut its full-year earnings forecast last month, a majority of the market focused on the headline figures. However, there is more going on for this cigarette maker which I will discuss in this article. Philip Morris announced its quarterly results this week and the company clearly showed that it knows how to generate profits better than what analysts expected. This is why share value climbed on Thursday when the company held its quarterly conference call. Let's analyze Philip Morris' performance.

Quarterly Experience

Source: Presentation

Philip Morris began its conference with an ironic statement when it said it delivered a strong quarter as volumes declined. While total cigarette shipments did decline to 222.8 billion, higher pricing brought total revenue (excluding currency impact) upward by 4.5%. However, this wasn't enough to bring the reported net revenue figure higher than what it was during the same period a year ago. As a result, revenue declined 150 bps overall to $7.8 billion.

Favorable volume and product mix in Italy together with price increases in Germany and Poland helped EU revenue jump 8.5%. The EMEA segment also gained through the new business layout in Egypt and price movement, particularly in the Russian territory. Latin America would have also posted a top line increase that was higher than anywhere else had negative currency movements not been present. As a result, revenue fell 3.5% to $810 million in Latin America.

It was the Asian market that remained a challenging task for the company. Japan has been going through tough times as cigarette industry volume has declined by 14.4% during the last quarter due to tax-driven price increases implemented during April. Apart from tougher macroeconomic conditions some negative contribution also emerged from the micro side with decreasing market share for the company.

Moving forward, gross profit declined 2.2% to $5.1 billion mainly due to higher excise tax. Operating income slipped 13.9% year over year to $2.8 billion as Philip Morris spent more on marketing, administration and research. The net result was diluted earnings per share of $1.17 falling by 13 cents or 10% compared to the figure of $1.30 reported in 2013.

These falling figures shouldn't be disappointing to investors as the future is not doomed to repeat past events. Philip Morris is changing its business structure to one which the company believes will allow benefits in the near future. To begin, the company is shifting its production from its old manufacturing plant in Australia to South Korea by the end of this year. Tough anti-tobacco regulations in Australia have been lowering sales and bringing pressure on profits lately. Furthermore, fire safety rules have been affecting exports from the production facility in the region. The decision will result in job cuts and prevent rising costs. Also, exporting from an area where regulations are less stringent in the future will allow Philip Morris to save on duties and other related expenses.

Similar closures are going to take place next year in the Netherlands factory. The company has already incurred costs related to an exit during its last quarter. They partly explain why EPS fell. If we exclude these costs, adjusted diluted EPS would have risen by 8.5% or 11 cents.

While these plans relate to closures and internal shifting, another point worth noting is that in the future products that are considered safer alternatives to conventional smoking will be in demand. Philip Morris has been actively seeking to push into the e-cigarette market as sales for traditional tobacco products are declining. This is why the company recently acquired Nicocigs, the UK's biggest electronic cigarette maker, with a market share of 27% in the local e-cigarette market. The latest acquisition by Philip Morris into the fast-growing market of tobacco-free smoking will not only provide the firm with sales that are generated in the UK market but also the expertise to develop its reduced risk products commonly known as iQOS.

iQOS heats rather than burns tobacco so it emits fewer toxins when heated at 400 Fahrenheit rather than being burned at 1600 Fahrenheit like a normal cigarette. The company will introduce these products in Japan and Italy this year since these are the locations where the IQOS are initially being produced. The device will be released in-line with Marlboro HeatSticks, which can be inserted into the device to add the sensation of tobacco flavor.

The venture is huge and Philip Morris has spent more than $2 billion over a decade on these two ventures. It is estimated that around 30 billion units of iQOS will be sold and will add $700 million per annum to profits in the coming three or four years.

Bottom Line

Philip Morris is going through a tough time but the company is preparing ahead by developing products that will be in high demand in the future. With the buyback program going strong and revenue growth historically above industry peers, Philip Morris' present strategy should reduce uncertainty among investors. With all of these plans in place, investors shouldn't be disappointed with present results and should enjoy the profits from the upcoming new products. Based on the points mentioned above, I recommend buying the stock.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.