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PM reported strong Q4 2013 results yesterday with revenues of $7.78B (slightly missing consensus expectations of $7.81B) and adjusted diluted EPS that beat consensus by 1 cent at $1.37. 

The headwinds we see for the company over the next two quarters have not changed – what’s impressive however is how well PM has been able to take pricing in the quarter to make up for volume declines and tax increases across most of its geographies. Overall volume declined -4.3% in Q4 and -5.1% in FY2013 while net pricing rose a robust +6.9% in Q4 and +6.6% in FY2013. Additionally, the company gained market share in all four of its main regions.

Concerns for us over the coming quarters remain volume declines in many of its core geographies on additional excise tax hikes, weak macro and consumer environments, and currency and illicit trade headwinds. In 2014, excise tax hike concerns remain in Japan, Indonesia, and the Philippines; weaker macros include Europe and Russia; and we expect currency weakness across much of the emerging market, including the Russian Ruble, Turkish Lira, and Argentine Peso, as the illicit trade across the region skims results.   

The company announced that it has issued 60% of its pricing for 2014 as of today (versus ~75% this time last year). We think the significant risks to it making its 1H numbers include: its ability to take additional pricing in Japan (it has submitted requests to the government for price hikes in April but has yet to be approved); weakness beyond its forecasts in the Philippines as the Mighty Corporation continues to undercut price (it only declares half of its production for tax); and macro weakness in Europe beyond its forecast of -6% to -7% (versus previous 2014 guidance of down -7% to -8%).

The company forecasts EPS guidance for 2014 of $5.02 to $5.12 (including a currency headwind of $0.71). It said it expects industry volumes to be down 2-3% in 2014 (ex-China), versus ~4% in 2013 and it will spend $4Billion in share repurchases in 2014 versus $6B last year. The company spent a very small amount of time discussing its Reduced Risk Products (RRPs), including e-cigs, despite major investments and partnerships that were announced in Q4 of last year -- this is concerning unless the company is particularly good at hedging its excitement about the segment (and contribution to earnings down the line). Remember late last year it announced  €500MM to build a RRP manufacturing facility in Italy, to be operation in 2016 with capacity of 30B units, and a strategic partnership with Altria (MO) to sell and partner with its non-combustion technology.  

We’ve had a bearish bias on the PM over the last two quarters and continue to suggest a pair trade of long LO versus short PM. See chart below on price performance.

What We Liked

  • Illicit trade in Europe has moderated. Sales in back half of 2013 have moderated versus larger declines in1H 2013.
  • In EU Region grew market share by 0.5% to 38.5% in 2013 vs 2012. Increases were across all brands.
  • Russia strong: pricing actions expanded profitability despite volume -7.6% in Q4. It increased pricing in December, and expects another hike at the end of February.  Volume in 2014 expected to be down 9 to 11%.

What We Didn’t Like

  • Japan still remains a challenged market. Company believes it will be able to fully meet consumption price tax increase in Japan from 5% to 8% in Japan in April with pricing, however risk that the government doesn’t approve it.
  • PM says demand for e-cigs in Europe has decelerated, which PM posits should boost traditional cigarette volumes in 2014.
  • Italian tax environment continues to be unfavorable.
  • Moderation in Turkey results on increased competition in Low and Super-Low segment. 

Call with questions. Have a great weekend!

Matt Hedrick

PM: Strong Pricing in Challenged Geographies - yy. spread