Philip Morris International, Inc.'s Best Segment in 2016 So Far

By Markets Fool.com

You can find products from Philip Morris International (NYSE: PM) in nearly every corner of the world. One of the challenges that Philip Morris has faced lately is that outside the U.S., economic conditions aren't as favorable as American investors are used to seeing, and that has translated into weak performance in many areas of the tobacco giant's global empire. Yet surprisingly, even though Europe has gone through more than its fair share of turmoil lately, Philip Morris' European Union segment has held up extremely well and has posted the most consistent gains in net revenue and operating company income of any of the company's regions. Let's take a closer look at Philip Morris' success on the continent and whether investors should count on it continuing.

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Some fear the Brexit vote could hurt the EU economy, but Philip Morris International isn't likely to see a huge amount of damage to its business. Image source: Getty Images.

Making the most of tough times

Philip Morris International's European Union segment competes with the Asia segment for supremacy on the revenue front, with the two regions trading places from quarter to quarter in taking the role of the largest producer of sales for the company. Indeed, so far this year, the European Union is lagging slightly behind Asia, with revenue of $4.02 billion compared to $4.1 billion for its eastern counterpart.

Yet there are a few things pointing in the EU's favor. First, the European Union was the only region to post an increase in revenue on a U.S. dollar basis. Even though that growth was only 0.2%, it was far better than the nearly 5% decline in Asia revenue and the double-digit percentage drops for the company's other segments.

In addition, the European Union has traditionally been more profitable for Philip Morris than its other segments. Profits for the first half of 2016 in the EU amounted to $1.98 billion, which was well above the $1.53 billion that the Asia segment earned. Also, the EU's bottom line grew by more than 2% from the year-ago period, standing in stark contrast to the other three segments, all of which saw operating company income fall by more than 10%.

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Finally, the adverse volume trends that Philip Morris has seen throughout its global distribution network haven't materialized in the European Union. So far this year, EU shipment volumes are up almost 1% to 96.4 billion units. Shipments elsewhere are much higher, but they've fallen recently, and the pricing power Philip Morris has in the EU is hard to duplicate elsewhere.

What's behind Philip Morris International's EU success?

Philip Morris sees several trends in its European Union business. A reversal in the strength of the U.S. dollar has been most obvious in the EU, which finally experienced a currency-related boost in revenue and income during the second quarter. Favorable pricing trends, especially in the German and Italian markets, have helped produce the attractive results in the EU, even though an unfavorable sales mix and higher costs related to commercializing reduced-risk products like the iQOS heat-not-burn technology have weighed on growth.

Overall, Philip Morris has room to grow in the EU. The company has market share of 38.5%, with Marlboro accounting for roughly half that amount. Within the region, Poland and Spain have seen the healthiest performance, with cigarette shipment volumes rising 8% to 9% despite relatively weak conditions in the broader tobacco industry. That has led to extensive market-share gains there of between one and two percentage points, showing the payoff of Philip Morris' Marlboro 2.0 initiative. France has also done reasonably well for the company as well.

That doesn't mean everything is going smoothly for Philip Morris. In both Italy and Germany, the company's shipment volume declined more than the overall industry, in part because of pricing moves that helped make competitors' products look more attractive from a pricing perspective.

Will the EU stay strong for Philip Morris?

Shocks like the U.K. Brexit vote are a big concern for many investors, but for Philip Morris International's business, the direct impact of a U.K. exit from the EU should be minimal. The potential pitfall, however, is if the episode leads to renewed currency weakness in the euro. Nevertheless, with such a strong history of success in Western Europe, Philip Morris can expect that the European Union segment will stay important to its overall results well into the future.

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