You may recall that I initiated coverage of Philip Morris International (NYSE:NYSE:PM) at $85.50 in fall of 2015. Since then shares are up a whopping 41%, but the name has had its ups and downs, allowing for strong add on opportunities as well as trading potential. The stock has enjoyed a major rally in the last few months, but now appears to be pulling back. Let me say that the name really has been all over the map. Back in April the name pulled back strong after rising $30 a share since December when there was rampant speculation that the company might by Altria (NYSE:MO) in a mega-merger. While that speculation led to trading, there was also a guidance update in February that led to more buying, as well as reports of strong demand for smokeless tobacco and new electronic nicotine products. I am checking back in on the name today as there are two timely pieces of news regarding the company.
First, we learned that in a somewhat potentially bearish piece of news, that youth tobacco use in the United States fell to historic lows in 2016. Public health officials went on to say that a smoke free generation may be within reach in the next few decades. Clearly this is not a positive for a company that sells cigarettes. In addition, Centers for Disease Control and Prevention data shows that the number of middle school and high school students utilizing any tobacco product fell to 3.9 million from 4.7 million in 2015. Now, the counter to this is that PM is now focused much more on selling smokeless and smoke free products.
This takes us to two other things we learned. First, PM is investing $320 million into a new high-tech facility in Germany to produce the devices and tobacco units that are used with its electronic tobacco heating device known as IQOS. This construction will begin later this year. This clearly shows that PM is serious about taking giant leaps forward into the smoke-free products which are replacing cigarettes. But that is not all. Just this morning, it was learned the company is pumping another $500 million into its smoke-free facility in Crespellano, Italy. This money will be used to expand production capacity to a much larger scale to make more of the tobacco units for IQOS electronic heating devices. This work should be done in 2018. The total goal is to be able to produce 100 billion heated tobacco units by the end of 2018. These two investments show that the company is recognizing the reduced demand for traditional cigarettes and the increased role that electronic cigarettes and smoke free tobacco are playing in society.
That all said, the same Centers for Disease Control and Prevention data mentioned above also contained data on e-cigarette use. Let us be real. Future sales depend on future customers. That is a fact. With less kids smoking (at least in the United States) there are lower demand for cigarettes. PM knew this would be the case and as such is investing in smoke-free products. However, the same survey data showing decreased cigarette use also showed a notable decline in e-cigarette use. In fact, the use of e-cigarettes dropped from 16% of high schoolers in 2015, down to 11.3% in 2016. This is terrible news. While this is a key piece of data, it doesn’t mean investors should panic. International sales remain strong, and is enough to offset U.S weakness.
Recall the company recently reported its Q1 which was poor on the surface. There was definitely sales pressure. The company took in revenues that were down 0.3% year-over-year to $6.06 billion. For years the company has seen trouble on the revenue side, either flat or down in many cases. So this result was unsurprising but it missed expectations by $410 million. If we exclude the unfavorable currency impact and look at revenues in constant dollars, we see a negative hit of $120 million due to currency issues. So, controlling for this, revenues were up 1.7% year-over-year. Much of this was due to pricing. That said, cigarette shipment volume was down 11.5% year-over-year. That is huge. Factoring in expenses, the company saw earnings of $1.02, up 4.1% from last year's Q1. However, if we factor in special items and look at a constant dollar basis, earnings per share were flat versus last year, hitting $0.98 per share.
With pressure on sales, and cigarette shipments down so markedly, the company is reinventing itself in the smoke-free space. Still, these results suggest the company continues to make money, but is continuing to stagnate. That is the risk to this company, the fact that public health entities everywhere are battling tobacco. Now they are focused too on electronic means. That said, hundreds of millions of people globally utilize the products. Shifting from traditional tobacco into 21st century electronic forms is what will keep sales coming in. The company is heavily focused on consumers switching from the classic tobacco products to those that heat as opposed to burn. Looking ahead, the company sees 2017 reported earnings per share forecast to be in a range of $4.84 to $4.99. This represents a projected increase of approximately 9 to 12% versus 2016 earnings. After this recent run-up in shares, I am now lifting my buy rating. Take some profit, and let’s look to buy back shares around $110.
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