A Rough Time For Philip Morris

| About: Philip Morris (PM)
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Philip Morris reported earnings of $1.19 per share and beat the consensus estimates of $1.17 with a 1.17% earnings surprise.

The number of smokers around the world is projected to rise to 1.64 billion by the end of 2025.

Philip Morris announced that it has purchased Britain’s largest e-cigarette manufacturer, Nicocigs Ltd.

The tobacco industry is suffering from sluggish demand, stricter regulations, and heavy tax duties. Although smoking is injurious to health there is still a large population of people around the world who smoke tobacco. The number of smokers and cigarettes produced are on the rise due to population growth. The number of smokers around the world is projected to rise to 1.64 billion by the end of 2025. The beneficiaries will be the world's six largest tobacco companies, who together control over 83% of the tobacco industry market.

Revenues from global tobacco sales are estimated to be just over $500 billion and the combined profits for the six largest firms will be $35.1 billion. China National Tobacco leads the industry and has a 37.5% market share in the global tobacco industry. The company targets over 350 million smokers. Philip Morris International (NYSE:PM) maintains roughly 16% of the global tobacco market or 28.3%, excluding China. Philip Morris has remained the largest tobacco company in the world by a comfortable margin. Philip Morris International generated $31.217 billion in revenues and had a net income of $8.576 billion in 2013. British American tobacco (NYSEMKT:BTI) has roughly 12% of the market followed by Japan Tobacco International with a 9.6% market share. Imperial Tobacco used to be a minor player but with a number of aggressive acquisitions the company now holds a more than 5% market share in the global tobacco market. Altria Group (NYSE:MO) dominates the U.S. tobacco market and it has a roughly 3% market share in the global tobacco market.

Source: mic.com

Recent Quarter's Results

The weak sales volume and earnings growth, mainly due to slow industry growth, has restricted the stock price movement in the last few quarters. Recently Philip Morris released the second quarter earnings results for fiscal year 2014. Philip Morris reported earnings per share of $1.19 and beat the consensus estimates of $1.17 with a 1.17% earnings surprise.

Philip Morris showed modest revenue growth driven by lower cigarette volume, which declined by 2.7%, and a solid pricing variance of $494 million. Investors must be concerned about the declining sales volume because in 2013 the company's sales volume declined 5.1%. Moreover the sustained public health campaigns combined with heavy taxes and marketing restrictions means that tobacco sales are less likely to grow again in the developed markets. In this case, the aggressively growing e-cigarette market is the hope to reaccelerate sales volume growth.

The net revenues, excluding excise taxes, dropped 1.5% to $7.8 billion. The currency headwind remained a challenge for the company as it adversely impacted the revenues. In fact, net revenues improved 4.5% excluding the unfavorable currency and excise taxes. The diluted per share earnings of $1.17 dropped $0.13 or 10% year over year; however, adjusted diluted earnings per share of $1.41 improved $0.11 or 8.5% year over year.

Expansion Into the E-Cigarette Market

The global e-cigarette market is set to grow at a CAGR of 30.56% from 2013 to 2018. The e-cigarette market in the UK is witnessing changes in lifestyle and preferences. The introduction of e-cigarettes in the tobacco industry has increased their adoption rate by a large number of smokers. The market is expected to witness huge growth in the demand for e-cigarettes from traditional tobacco smokers during the next several years.

The e-cigarette market in the UK is driven by many growth factors, one of which is the increased desire among consumers to quit smoking tobacco. According to recently released statistics, the usage of electronic cigarettes among adults in Britain has tripled over the past two years from an estimated 700,000 users in 2012 to 2.1 million in 2014. Nearly two-thirds of users are smokers and one third are ex-smokers reflecting an increase in the proportion of ex-smokers compared to previous years. The adoption of e-cigarettes among smokers is a vital opportunity and recently Philip Morris announced that it purchased Britain's largest e-cigarette manufacturer, Nicocigs Ltd.

Previously, Altria Group partnered with Philip Morris to capitalize on the growing electronic cigarette industry. Not long ago the two released the MarkTen e-cigarette, which now sits on the shelves of retail chains all across the United States. Now, Phillip Morris wants to expand even further with the purchase of the Birmingham-based Nicocigs, which is a rather small company on a global level, but happens to be the largest player in the U.K. and has a market share of 27% in the U.K. e-cigarette market.


Source: ycharts

An initial glance at the company's second quarter earnings and the chart above shows why the stock is underperforming. But if corrected for currency fluctuations and one-time items, the company actually reported an 8.5% increase in earnings. Similarly the revenues adjusted for currency fluctuations and excise taxes increased 4.5%. In short, the company's earnings stream improved with modest growth and successful cost-cutting measures.

The stock is trading at a forward price to earnings multiple of 15.34 times while in comparison Reynolds American Inc. (NYSE:RAI) is trading at 16.20 times. In the next five years Philip Morris's per share earnings are expected to grow at an average growth rate of 6.83%, which is quite reasonable. Coupled with its dividend paying nature and projected earnings growth, Philip Morris is still a sound investment. Once its strategies start bearing fruit, Philip Morris could perform even better.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Business relationship disclosure: The article has been written by a Gemstone Equity Research research analyst. Gemstone Equity Research is not receiving compensation for it (other than from Seeking Alpha). Gemstone Equity Research has no business relationship with any company whose stock is mentioned in this article.