Image source: Philip Morris International.
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The second-quarter financial report from Philip Morris International (NYSE: PM) didn't give investors everything they wanted from the tobacco giant, as declines in cigarette shipment volumes led to weaker revenue and net income figures than most of those following the stock were looking to see. Even though company executives stayed upbeat about the tobacco giant's long-term prospects, many investors weren't as confident about Philip Morris' near-term ability to bounce back from its recent woes. Following the report, CFO Jacek Olczak conducted his usual conference call and discussed several important issues facing the company.
Let's take a closer look at what Olczak had to say about Philip Morris.
1. Currency impacts on Philip Morris are starting to let up
The $0.05 moderation in the currency impact on our guidance primarily reflects the appreciation fo the Japanese yen and the Russian ruble against the U.S. dollar since we last provided guidance in April.
The single biggest thing holding back Philip Morris lately has been the strength of the U.S. dollar, which in recent years has posted huge gains against major currencies like the euro and the Japanese yen. In addition, key Philip Morris markets like Russia have also experienced weaker currencies compared to the dollar, and that has hurt both top-line and bottom-line performance for the tobacco maker.
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Now, however, the dollar has paused in its upward advance against most major currencies. That, in turn, has reduced the headwinds holding back Philip Morris' results, and the company's guidance going forward has steadily improved thanks entirely to currency impacts. For quite a while, Philip Morris has produced impressive growth when you take out currency effects, and investors increasingly believe the worst is over for the company on the foreign-exchange front.
2. Philip Morris continues to rely on strong pricing
Our favorable pricing volumes of $344 million in the second quarter reflected positive contributions from all regions, notably [the European Union] and [Eastern Europe, Middle East, and Africa].
Philip Morris had another poor quarter of cigarette shipments, with volumes falling nearly 5%. The pace of decline has dramatically accelerated compared to the first quarter, and it has been essential for Philip Morris to boost prices in response in order to keep sales from falling even further. As we've seen in past quarters, the company announced and implemented price increases in many markets. In particular, an increase of 10 yen per pack in Japan became effective on Aug. 1, and that should help contribute to Philip Morris' anticipated positive pricing variance of about 6% for the full 2016 year compared to 2015 figures.
3. Philip Morris has high hopes for iQOS
iQOS was present in 10 markets by the end of June, following its commercialization in select cities in Denmark, Germany, and Monaco. We remain on track to launch iQOS in key cities in around 20 markets by the end of this year.
Philip Morris' answer to falling cigarette volume is to highlight its reduced-risk product line, and the early success of iQOS and its heat-not-burn HeatSticks has been encouraging to the company. Initial favorable results in Japan have remained encouraging, and ongoing rollouts in Italy and Switzerland are developing well. In particular, cannibalization from Philip Morris' conventional cigarette sales has fallen slightly, and the fact that HeatSticks are premium priced has led to stronger results as users of discount products trade up to iQOS. Market share in Japan doubled in just three months to 2.2%, and although that's small for now, it points to the future potential iQOS has.
4. Buybacks might not come back soon
I think if we were to raise the buyback, we would like to see the positive outlook for the next few years [to have] a longer-lasting program than just one quarter or one year with a buyback.
Philip Morris suspended its buyback program when currency pressures increased in past years, but some investors want to know when share repurchase activity might resume. Olczak noted the highest priority item for the company remains sustaining its dividend, which currently carries a fairly high earnings payout ratio. After that, strategic investment is the next highest priority, with buybacks coming last. As a result, the CFO's comments strongly suggest Philip Morris investors will have to wait a while before they'll see any benefit from stock repurchases.
5. Geopolitical challenges could hit Philip Morris
You have some down-trading in some places in North Africa. In Egypt, as you know, the macroeconomic situation is challenging. And Egypt will remain on the watchlist for the remainder of the year.
Most of the political issues Philip Morris has faced lately center on plain-packaging regulation. However, the cigarette maker is also vulnerable to broader market disruptions, and with increasingly political instability on Africa's Mediterranean coast, Philip Morris notes that the possibility of a major macroeconomic impact on the region could affect the future direction for the regional segment. If consumers have to pull back, Philip Morris could see further downward pressure in areas affected by political challenges.
Philip Morris has pulled back somewhat from its record-high stock prices, but investors remain comfortable with its dividend and its long-term prospects. The main question going forward is whether the tobacco giant can find new ways to grow and overcome the rising challenges it faces in many key markets. If it can, then the stock has room to rise further.
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