Philip Morris (NYSE: PM ) released its first-quarter results last week, and the market did not like what it saw.
Indeed, the company reported that its headline EPS figure had slumped 7.8% year-over-year thanks to falling tobacco sales and contracting margins. However, aside from this headline performance, there are other worrying numbers hidden within the company's results.
Taking a closer look
So, how do things look? Let's dissect the results to try to figure out what's really going on.
If we strip out unfavorable currency effects, Philip Morris' earnings per share for the quarter actually jumped 4.7% year-over-year. On an adjusted basis and excluding the effect of currency, EPS grew by the same 4.7%; with the inclusion of the negative currency impact, non-adjusted EPS only slumped 7.8%.
Still, I prefer not to rely on adjusted earnings figures, as the accounting methods used to arrive at these figures can be misleading. Nevertheless, it would appear that for the most part, Philip Morris had a pretty terrible first quarter. The volume of cigarettes shipped by Philip Morris during the quarter declined 4.4%.
What is of more importance, though, is that the volume of Marlboro cigarettes shipped by Philip Morris during the year only declined 4.1% -- worrying, but better than the overall trend. Marlboro sales make up the majority of Philip Morris' overall sales, and these cigarettes are by far Philip Morris' most profitable product in terms of gross margin. Sales of Marlboro are also declining at a slower rate than the company's average. However, there is one bright stop in the company's earnings: the Philippines.
Philip Morris' tobacco shipments to the Philippines have come under pressure during the last few quarters after a change in excise tax rates hiked the price the company had to charge for its cigarettes.
Nevertheless, during the first quarter, the company reported that Marlboro shipments to Asia by units jumped 0.8%, led by Indonesia and the Philippines; however, the adverse timing of shipments in Japan and a lower market share in Pakistan had offsetting effects.
Sales data aside, the things that interest me the most about Philip Morris' most recent set of earnings are the company's outlook and operating margin.
Margins are important
One of the reasons that big tobacco has been able to remain so profitable during the last few years despite sliding cigarette sales volumes is that its profit margins have been expanding. Indeed, big tobacco has been able to use rising excise taxes to disguise its own price hikes and this has led to widening margins.
Worryingly, this was not the case during 2013. Philip Morris' operating margin for 2013 actually declined from 17.8% in 2012 to 16.9%. In part, this margin compression resulted from higher excise taxes across the board, and for some reason Philip Morris failed to mitigate these increases through price hikes. Sadly, this trend has continued into 2014.
For the quarter, Philip Morris' operating income slumped 13% even though its revenue only declined 8.8%. In addition, excise taxes as a percentage of revenue ticked up to 61% from 59% in the same period of 2013.
Despite this bad news, Philip Morris' management did have something good to report in the form of a better outlook for 2014.
The company now expects to report EPS of $5.19, at the high end of estimates that exclude currency effects for the full year of 2014; this reflects a lower negative currency charge of $0.61, as the company previously expected a charge of $0.71.
Meanwhile, Altria (NYSE: MO ) , Philip Morris' partner in crime here in the U.S., has just reported a solid set of first-quarter results, which shows that without the negative effects of currency big tobacco is still very much capable of growth and profitability.
Excluding the effect of special items, Altria's first quarter EPS ticked higher by 5.6% year-over-year to $0.57. Altria's management also raised its 2014 EPS forecast from $2.51-$2.58 up to $2.53-$2.60 -- this implies growth of at least 6% for the year.
Like Philip Morris, Altria also reported a decline in the number of cigarettes shipped; the volume of Marlboros shipped slid 2.4% for the quarter. However, unlike Philip Morris, Altria's revenue from smokeless products jumped 6.4%, and its smokeless operating income increased 7.7%.
Altria's smokeable-products revenue declined 0.2%, but due to an operating margin improvement of 2.2% the company's operating income from smokeable products jumped by 6.4%. Ste. Michelle, Altria's wine subsidiary, reported strong growth with its sales jumping 2.4% year-over-year; a 1.2% increase in margin meant that operating income from wine increased by 10%.
So all in all, collapsing margins, rising excise taxes, unfavorable currency movements, and falling cigarette sales are all putting pressure on Philip Morris' earnings. Unfortunately, it looks as if these factors will continue to weigh on the company.
Still, Philip Morris' sales have started to expand again within the Philippines so it's not all bad news for the company. However, in comparison with Altria's set of relatively good results, Philip Morris looks to be a poor investment.
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