Canada Hits Philip Morris With A Feather; Plain Packaging Tickles

| About: Philip Morris (PM)

Summary

Canada announced plain packaging laws to destroy the tobacco industry.

Those laws may be strict, but they are also virtually useless.

Displays were already banned and 75% of the box was covered in graphic warnings.

Analysis of revenues from market segments and shipments to different countries reveals the value of Canada’s market to Philip Morris.

If this new regulation can take even .5% off of earnings, it would be an astounding success for Canada.

Investors in the big tobacco companies like Philip Morris (NYSE:PM) could be scared by plain packaging regulations, but there is little cause for concern. While Canada instituted new plain packaging laws, the impact should be fairly minor. Canada already had bans on point-of-sale displays so it seems highly doubtful that smokers were being heavily influenced by the colors on a specific box. Keep in mind most of the box was covered with graphic warnings anyway, so this represents a change to a small portion of a box that is stored away from the customer.

In a nutshell, the only time the consumer is aware of this change is when he or she is looking at their pack of smokes and says: "I thought this box used to be a different color".

Implications

Since the point of sale ban was already in place it was going to be incredibly difficult for new competitors to enter the market. Customers would already need to request their brand by name rather than pointing to it. It seems highly questionable that changing the color of the box carrying the graphic health warnings is going to be a huge victory in preventing smoking, but indulge me for a moment anyway.

Sales in Canada and Latin America

Philip Morris doesn't report Canada as an entire segment. They lump it together with Latin America. That makes the numbers a little rougher, but we can still get a feel for the importance of the combined market:

Click to enlarge

In total Canada and Latin America represent less than 10 of earnings before taxes.

If we don't require earnings data and just want to know more about the number of units sold there are some charts on the market share for Argentina, Canada, and Mexico on pages 59 and 60 of the 10-Q.

The most relevant number for comparison is the total volume of PMI shipments. This tells investors how many millions of units PM sent to each country. Canada got 2,184, Argentina got 7,526, and Mexico got 5,982. In other words, for the first quarter about 14% of the total units shipped to this segment were shipped to Canada. Therefore, we can assume that Canada represents about 14% of the net earnings for the segment. That segment represents a little less than 10% of the earnings for the company, so Canada contributes somewhere in the ball park of 1.4% of earnings.

Even if changing the color on the 25% of the box that isn't covered by graphic warnings reduced PM's earnings in the country by 30% (that seems extreme), it would cut less than .5% off the earnings the company produces. Should this really be seen as a big deal?

Conclusion

The plain packaging headlines may seem like a big deal, but it couldn't be less relevant for Philip Morris. At the most extreme projections of a 30% sales decline it would still be less than .5% off earnings. It seems hard to conceive of a 30% sales reduction coming from a decline in the amount of color choices and trademark usage allowed on the 25% of the box that wasn't already covered with graphic warnings. It seems even more absurd given the laws already in place restricting the display of the product.

In a nutshell, this story is a non-story. It is great for getting some PR, but it shouldn't factor into an investor's decision about buying or selling PM. It is unlikely to have a material impact on Canada's consumption levels, but if it does the result would still be negligible because Canada is not a major source of profits or growth.

Disclosure: I am/we are long PM.

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