Philip Morris Earnings Show Continued Underlying Business Momentum

| About: Philip Morris (PM)
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Prior to the market open on July 19th, Philip Morris (PM) reported EPS of $1.36 compared to EPS of $1.35 same quarter last year. The company also reaffirmed guidance to be in the range of $5.10 to $5.20 versus $4.85 in 2011. PM is trading at $90, a 1% gain intraday.

Notable Quotes from the Earnings Press Release and Webcast Slides:

Net revenues of $8.1 billion were down by 1.8%, including unfavorable currency of $402 million. Excluding currency, net revenues increased by 3.0%, driven by favorable pricing of $463 million, partly offset by unfavorable volume/mix of $225 million.

Excluding currency, operating companies income was up by 3.4%, driven by higher pricing, partly offset by unfavorable volume/mix of $245 million, higher manufacturing costs and increased investments behind the new Marlboro advertising campaign, notably in Germany and Switzerland, new brand launches, notably Marlboro Edge in Japan and Marlboro ClearTaste in Russia, business infrastructure in Russia and anti-illicit trade investments, including organizational infrastructure and the recently announced agreement with Interpol.

PMI's cigarette shipment volume was down by 1.2%, excluding acquisitions. Excluding acquisitions, and the Japan hurdle of 6.3 billion units which is related to additional volume shipped in the second quarter of 2011 following the disruption of PMI's principal competitor's supply chain, PMI's cigarette shipment volume grew by 1.4%.

In the EU, PMI's total cigarette shipment volume decreased by 9.4% in the quarter, predominantly due to a lower total market, particularly in southern Europe.

The total cigarette market in the EU declined by 9.7% to 132.2 billion units in the quarter, due primarily to: tax-driven price increases; the unfavorable economic environment, particularly in southern Europe, and the impact of related austerity measures; the growth of the OTP segment, notably in Greece, Italy and Spain; the prevalence of illicit trade, mainly in Greece, Italy and Poland; and the timing of Easter 8 trade inventory movements. June year-to-date, the total cigarette market in the EU declined by 5.8% to 258.2 billion units.

Volume/mix variance was obviously negative in the quarter due to the Japan hurdle. However, as you can see on the chart, excluding the hurdle, eight of our top ten brands grew volume in the first half of the year and the other two were essentially stable.

Things to Note:

Strong underlying business results lead to a more or less in-line result with analyst estimates. The excerpts above report some volume shipment loss, but this is primarily due to comparisons to Q2 2011 including the "Japan hurdle", an expected comparison hurdle. PM experienced increased volume to Japan and Asia due to the natural disasters affecting Japanese cigarette maker' supply chains; this unusual increase in volumes results in unfavorable comparisons.

An important thing to note is unfavorable currency headwinds, specifically the strengthening dollar compared to foreign currencies, especially the Euro. PM believes these headwinds will be offset by "an anticipated improvement in business performance driven largely by Asia and EEMA" (Eastern Europe, Middle East, and Africa Region) moving forward. If currency and Japan hurdles are ignored, adjusted diluted EPS would be up by 17.7% compared to Q2 2011.

Free cash flow in the quarter declined $703 million to $3.2 billion, but this can be accounted for by unfavorable currency movements (over $350 million of the decrease) and an increase in working capital, where Philip Morris built up finished goods inventory. The increase in working capital should be negated in the third quarter as these inventories are sold.

Revenue Changes by Region



First Half










Latin America






Overall, weakness in Europe fueled slightly declining revenues, which were offset by favorable pricing as PM has been able to continue to increase prices (IE: inelastic demand curve of cigarettes). Asian growth must be considered against the Japanese hurdle, a reported -.7% decline masks the fact that Indonesia drove Asian sales up 7.4%. EEMA represents an area of strong potential, with Russia fueling growth as Philip Morris outpaces industry volume in the country and many foreign workers return to Russian construction jobs. Looking forward, continued weakness in EU will drag on otherwise bright prospects from EEMA and Asia. Philip Morris notes the continually deteriorating job market in Europe in its Q2 results webcast leading to declining overall markets, while PM has retained its cigarette market shares despite increased pressures from local brands. PM continues to lead in the often higher priced 'fine cut' tobacco products while facing competition at lower pricing levels

Units Shipped by Product


Units in Billions

% Change







Bond Street






Philip Morris












Here, it is important to keep in mind the Japan hurdle. Lark, for instance, is down about 15% compared to Q2 2011 but excluding the Japanese hurdle it actually increased volumes by less than a percent. In the EEMA region, all brands except for Chesterfield saw increased volumes.

Finally, Philip Morris' extension into a new three year $18 billion share repurchase program will begin in August with a target buyback of $6 billion in shares for 2012. At a current price of $90, this would lead to a repurchase of 66 million shares. With a current 1.7 billion shares outstanding, the share drawdown in 2012 should decrease outstanding shares by about 3.9%.

Ultimately, Philip Morris' "breadth of footprint, superior brand portfolio, and continued strong pricing environment" continue to drive growth in the face of very weak demand out of Europe and related currency headwinds due to a strengthening dollar. On a currency neutral basis, EPS should grow 10 to 12%. Although PM trades at a premium when looking at its P/E ratio (currently 17 compared to a historical average of 14), its EPS growth combined with a strong dividend makes me bullish on the stock. I believe that PM will continue to deliver strong underlying business results regardless of economic conditions.

Disclosure: I am long PM.