PM – Underperformance Continues

Philip Morris International reported Q3 2013 results this morning that mostly reflected a continuation of last quarter’s weak performance.  For now the third straight quarter this year the company revised down its FY EPS guidance, to $5.35-5.40 vs prior guidance of $5.43-5.53, citing FX headwinds, restructuring costs, and macro developments.    

 

Despite some mild improvements sequentially, our call remains that PM will be challenged to meet its FY guidance given a weak macro environment across its regions and due to pressures from excise tax hikes and increased illicit trade.  On the margin, last night’s debt ceiling compromise could put upward pressure in the U.S. dollar, and therefore provide a further headwind for Q4 results.

 

Our preferred tobacco play on the long side remains Lorillard (LO).


 

On the Quarter:


Optically, revenues were in line with consensus and showed a big improvement sequentially at +0.1% versus -2.5% in Q2 2013, however Q3 was against a very easy comp of -5.3% in Q3 2012. Total volume was down -5.7% Y/Y (a deceleration versus -3.9% last quarter). PM was able to take pricing despite challenged volume results and printed EPS of $1.44 (in line with consensus), and +12% above the previous year quarter.

 

Under the Hood:

  • Volumes down across all regions (EU, EEMA, Asia, and LA & Canada)
  • Asia Notably Weak: volume down -7.8%; revenue down -7.9%
  • Excise tax hike taken in January 2013 in the Philippines continues to be a significant hit to volumes, with further hike(s) expected; tax hike in Indonesia expected to be announced next month
  • EU Stronger: revenue up +7.3%, with share momentum across all brands in region
  • Weakness in France’s volume (-10.8%) partially offset by strength in Germany (+0.8%)
  • Russia seeing strong pricing alongside -10.1% volume hit
  • CFO Olczak marginally bullish on the EU Tobacco Products Directive:
    • Places size of health warning at 65%  (vs 75% proposed)
    • Flavored cigarettes, such as menthol, to be banned in 8 years instead of 3
    • Slim cigarettes permitted
    • E-cigs to be regulated as tobacco product, not as medical devices

On E-cigs:


CFO Olczak is positive on the EU Tobacco Directive as it relates to regulating e-cigs as tobacco products and not as medical devices.  He reiterated that PM is working on a few alternative products (including an e-cig) that are slated for full commercialization in 2016-17. With regards to PM being late to the E-cig show, Olczak said that most e-cig makers now focus much of their attention on marketing, and less on the product, and PM’s focused on going to market with the right product, not about being the first mover.

 

While we think next generation products will turn more attention to product development to mimicking even closer a traditional cigarette, we would be concerned that PM’s big tobacco rivals and a few select private players also have significant budgets and R&D underway to bring better e-cig products to the market (and perhaps sooner than PM’s extended timeline). The caveat here is that as regulatory frameworks around e-cigs evolve globally, the landscape, and players involved, is subject to change.

 

PM Levels:


PM is trading below our intermediate term TREND duration level of $90.44 and below our immediate term TRADE level of $90.05. This is an indication to use to remain bullish on the stock.

 

PM – Underperformance Continues - z. pm

 

Matthew Hedrick

Senior Analyst