Philip morris earnings preview: regulatory headwinds continue to challenge growth — trefis

Philip Morris International (NYSE PM) is set to report its 2014 first quarter earnings on April 17. We expect the company’s deteriorating market share in the Philippines, where a sharp hike in indirect taxes implemented last year disrupted an otherwise flourishing tobacco industry, to negatively impact its results. We also expect Philip Morris’ weak performance in the European Union (EU) to continue, primarily because of the growing prevalence of illegal trading of cigarettes in the region. Furthermore, the company’s performance in the Eastern Europe, Middle East and Africa (EEMA) region is not expected to be great either because of the tightening of anti tobacco regulations in Russia, one of the biggest tobacco markets in the region.

Philip Morris International is a leading international tobacco company with its products sold in more than 180 countries worldwide. Until its spin off in March 2008, Philip Morris International was an operating company of Altria Group (NYSE MO). Excluding the U.S. and China, the company holds more than 28% of the total international cigarette market, led by its flagship brand Marlboro.

We currently have a $80 price estimate for Philip Morris International, which is almost in line with its current market price.

See Our Complete Analysis For Philip Morris International


Deteriorating Market Share In Philippines

Almost 47% of the total volume decline reported by Philip Morris International last year can be attributed to its operations in the Philippines. Following a sharp hike in indirect taxes in the country, the company raised the prices of its Marlboro and Fortune brands by around 60% and 70% respectively. However, a local competitor, Mighty Corp., held back its pricing in the lower price segment, which allowed it to gain significant market share during the year. From mid single digits in 2012, Mighty s market share zoomed to over 20% last year. 1

As a result, Philip Morris International, that had a tight grip over the Philippines market with over 90% market share in 2012, recorded a steep (26% y o y) decline in cigarette shipments to the market last year. The company believes that Mighty Corp. is understating its tax paid cigarettes (for which all applicable taxes are paid) volume, which is allowing it to sell at extremely low prices. However, the Bureau of Internal Revenue (BIR) of Philippines is still investigating the case and there have been no findings supporting the company’s claims yet. Since there are no clear signs of improvement in Philip Morris’ deteriorating market share in the Philippines, we believe that it would remain a challenging market for the company this year as well. 2

Industry Headwinds In The EU Continue

Philip Morris EU operations have been under pressure over the past few years due to the growing prevalence of illegally traded cigarettes in the region amid weak macroeconomic conditions and a difficult regulatory environment for tobacco products. The continuous rise in excise taxes on cigarettes amid high unemployment rates is driving consumers towards cheaper options in the EU. The most popular cheaper alternatives include illegally traded cigarettes and other tobacco products.

Illegal trading of cigarettes is a huge concern for the local governments as well as cigarette manufacturers in the EU. Its growing prevalence in the region has been exaggerating the decline in tax paid cigarette consumption. The number of tax paid cigarettes consumed in the EU has declined by 20% over the past five years while the overall cigarette consumption in the EU has declined by just 17%. This is primarily because the number of illegally traded cigarettes consumed in the region has grown by 8% to 65 billion units over the same period. We estimate the number of illegally traded cigarettes consumed in the EU in a given year as a difference between the total number of cigarettes consumed in the region and the number of tax paid cigarettes consumed. First, we derive the number of the tax paid cigarettes consumed using market share and shipment volume data provided by Philip Morris. Then, we use the percentage share of illicit trade as estimated by the European Commission to calculate the total number of cigarettes consumed in the EU. 3

Many consumers in the EU have also been gravitating towards other tobacco products (OTP) of late. In most countries, excise taxes on tobacco products other than cigarettes (cigars, cigarillos, fine cut tobacco for hand rolling cigarettes, pipe tobacco, snus, chewing tobacco and so on) are subject to much lower excise taxes compared to manufactured cigarettes. This makes them relatively cheaper, and hence affordable. 4

Because of these factors, cigarette companies in the EU have been reporting sharp declines in shipment volumes. Philip Morris reported that its shipment volume in the EU dipped by 6.5% y o y last year despite being able to grow its volume market share by 40 basis points over the same period. We expect the company s shipment volume in the EU to continue to remain under pressure this year, as we do not see the underlying trends easing drastically in the short term. 5

Tightening Anti Tobacco Laws In Russia

Russia, the world s second largest market for cigarettes, has further aggravated operating conditions for Philip Morris International. Last year, the company’s sales volume in the country declined by almost 7% as a result of the implementation of excise tax hikes and other anti tobacco measures. Specific excise tax on cigarettes was increased by more than 40% y o y last year. Apart from this, a new anti tobacco bill that was signed into law on February 25, 2013, also came into effect on June 1, 2013.

The new anti tobacco law aims to reduce annual smoking related casualties in Russia by half over the next decade by restricting the marketing and sale of cigarettes, and smoking in public areas. It initially banned smoking at schools and universities, museums, sports facilities, hospitals and on public transport, but would be extended to cafes, restaurants and hotels this year. It also includes provisions for implementing a minimum price on cigarettes starting this year and banning tobacco sales at street kiosks. Therefore, business environment in Russia is expected to continue to remain harsh for Philip Morris International this year as well. 4

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Notes

  1. How A Small But Mighty Player Changed PH Cigarette Industry, &#8617
  2. Mighty Tobacco Corp. Willing To Open Books, &#8617
  3. Stepping up the fight against cigarette smuggling and other forms of illicit trade in tobacco products A comprehensive EU Strategy, European Commission, June 6, 2013 &#8617
  4. Slide Presentation, &#8617 &#8617
  5. Philip Morris International SEC Filings, &#8617

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