Philip Morris' Second-Quarter Report Didn't Mention the 1 Thing That Could Sink Its Stock

Philip Morris beat earnings expectations and showed promise in Europe, but it didn't mention the one thing that could leave shareholders sitting on a big loss.

Jul 22, 2014 at 9:00AM

Shares of Philip Morris International (NYSE:PM) are trading slightly higher after strong pricing enabled the company to beat Wall Street's second-quarter earnings forecast. The company reported a 20% increase in earnings per share after adjusting for currency fluctuations and other items. Philip Morris also reaffirmed its full-year guidance after it had lowered it at an investor day conference last month. Europe is improving and emerging markets can be fixed, but one thing that Philip Morris didn't tell investors could have a huge impact on the stock in 2015 and beyond.


Photo credit: Philip Morris International

Quarter recap: Strong in Europe, weak in Asia
Overall cigarette volume declined 2.7% in the quarter compared with the same quarter last year. The drop was most pronounced in Asia, where volume declined 6.7% compared with the 2013 period due to poor sales performance in Japan and the Philippines. Volume increased 2.7% in Europe and pulled back to near-even in the region for the first two quarters of 2014. This continues the narrative of a recovering European market and a deteriorating Asian market.

The Asian segment continues to be dragged down by a major competitor in the Philippines that Philip Morris accuses of bypassing excise taxes, thus giving the competitor an unfair price advantage. The Philippines tax-paid market declined a whopping 13.4% in the quarter. After adjusting for inventories, industry tax-paid volume is down a more modest 1.2% on the year.

Philip Morris CFO Jacek Olczak believes that tax stamps and other measures taken by the Philippine government will help curb tax evasion. "I think the tax stickers implementation is an important step in the whole portfolio of the steps which we wish the government should have already taken to address that issue," said Olczak on Thursday's conference call with Wall Street analysts. Philip Morris accounts for nearly 86% of the tax-paid market, so it is crucial that the company successfully lobbies the government for tougher restrictions on locally based tax-evaders.

Japan is another sore spot for Philip Morris' Asian markets. The Japanese cigarette market has declined by 2.8% since the start of the year, with a fall of 3% to 3.5% expected for the full year. The decline was only offset by low-single-digit increases in Indonesia and Korea. However, demand could pick back up again if economic activity increases in the years ahead.

An issue investors can no longer ignore
Despite the weakness in Asia, Philip Morris still reported strong currency-adjusted results. After adjusting for one-time accounting items, currency-neutral income increased by 9.5% in the quarter -- a solid result for a company that is struggling to grow shipment volume. However, currency fluctuations have the potential to cause investors serious pain in the coming years.

It is no secret that Philip Morris' earnings have been increasingly affected by adverse currency fluctuations. Exchange rates lowered its earnings by 4% in 2012, 6% in 2013, and an estimated 11% for full-year 2014. Unfortunately, the trend could worsen in the years ahead.

If the Federal Reserve tightens monetary policy by raising interest rates, Philip Morris could experience the double shock of a stronger dollar and weaker emerging market economies. When interest rates rise in the US, the dollar is apt to appreciate against foreign currencies like the euro and Japanese yen. If this occurs, it would lead to even worse currency translations and lower dollar-denominated earnings for Philip Morris.

Moreover, rising US interest rates negatively impact other economies, particularly in Europe and emerging markets. The Bank for International Settlements estimates that dollar-denominated international credit topped $7 trillion in 2014, far more than any other currency. This means that dollars are the life-blood of economies around the world. When dollars become more expensive (i.e., appreciate relative to other currencies), the cost of executing dollar-denominated transactions increases -- which leads to fewer transactions and lower economic activity.

The dollar's enormous impact on foreign currencies is part of the reason why the so-called BRIC nations -- Brazil, Russia, India, and China -- are taking steps to reduce their reliance on the currency. James Rickards, author of Currency Wars, told Russian news service RIA Novosti that "by shifting its policies, the Fed massively affects foreign currencies and makes it difficult for them to plan investments." Unless the dollar hegemony reaches a swift end, rising US interest rates will have an adverse impact on Philip Morris' earnings going forward.

Foolish takeaway
Philip Morris prepared investors for lower earnings during an investor conference last month, so the company's second-quarter earnings beat on lower expectations is not anything to cheer. Still, higher volume in Europe and the prospect of better performance in the Philippines remain bright spots for the company.

However, an appreciating US dollar could spoil earnings growth in 2015 and beyond. If the Federal Reserve raises interest rates this year or next, it could send a shockwave through the global economy that slows international trade and decreases the value of profits abroad in dollar terms. If this were to happen, Philip Morris might become a tax-loss candidate for investors come December.

Top dividend stocks for the next decade
Philip Morris investors will find safety in these dividend stocks. The smartest investors know that dividend stocks simply crush their non-dividend paying counterparts over the long term. That's beyond dispute. They also know that a well-constructed dividend portfolio creates wealth steadily, while still allowing you to sleep like a baby. Knowing how valuable such a portfolio might be, our top analysts put together a report on a group of high-yielding stocks that should be in any income investor's portfolio. To see our free report on these stocks, just click here now.

Ted Cooper has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

4 in 5 Americans Are Ignoring Buffett's Warning

Don't be one of them.

Jun 12, 2015 at 5:01PM

Admitting fear is difficult.

So you can imagine how shocked I was to find out Warren Buffett recently told a select number of investors about the cutting-edge technology that's keeping him awake at night.

This past May, The Motley Fool sent 8 of its best stock analysts to Omaha, Nebraska to attend the Berkshire Hathaway annual shareholder meeting. CEO Warren Buffett and Vice Chairman Charlie Munger fielded questions for nearly 6 hours.
The catch was: Attendees weren't allowed to record any of it. No audio. No video. 

Our team of analysts wrote down every single word Buffett and Munger uttered. Over 16,000 words. But only two words stood out to me as I read the detailed transcript of the event: "Real threat."

That's how Buffett responded when asked about this emerging market that is already expected to be worth more than $2 trillion in the U.S. alone. Google has already put some of its best engineers behind the technology powering this trend. 

The amazing thing is, while Buffett may be nervous, the rest of us can invest in this new industry BEFORE the old money realizes what hit them.

KPMG advises we're "on the cusp of revolutionary change" coming much "sooner than you think."

Even one legendary MIT professor had to recant his position that the technology was "beyond the capability of computer science." (He recently confessed to The Wall Street Journal that he's now a believer and amazed "how quickly this technology caught on.")

Yet according to one J.D. Power and Associates survey, only 1 in 5 Americans are even interested in this technology, much less ready to invest in it. Needless to say, you haven't missed your window of opportunity. 

Think about how many amazing technologies you've watched soar to new heights while you kick yourself thinking, "I knew about that technology before everyone was talking about it, but I just sat on my hands." 

Don't let that happen again. This time, it should be your family telling you, "I can't believe you knew about and invested in that technology so early on."

That's why I hope you take just a few minutes to access the exclusive research our team of analysts has put together on this industry and the one stock positioned to capitalize on this major shift.

Click here to learn about this incredible technology before Buffett stops being scared and starts buying!

David Hanson owns shares of Berkshire Hathaway and American Express. The Motley Fool recommends and owns shares of Berkshire Hathaway, Google, and Coca-Cola.We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

©1995-2014 The Motley Fool. All rights reserved. | Privacy/Legal Information