Tobacco farm. Source: Philip Morris International.
Alone among major U.S. tobacco companies, Philip Morris International (PM 0.31%) faces the challenge of dealing with currency risk. Unlike former parent Altria (MO 1.14%) and its domestic peers, all of Philip Morris International's sales come from abroad. As a result, Philip Morris must manage currency fluctuations, and when the U.S. dollar is strong the company often sees substantial hits to revenue and earnings. That was definitely the case in Philip Morris International's third-quarter earnings results this morning, but the global tobacco giant still believes it can overcome currency-related headwinds to produce long-term growth.
What the dollar did to Philip Morris
In terms of headline numbers, Philip Morris actually had a relatively strong quarter. Revenue came in at $7.9 billion after adjusting for excise taxes, which was down 0.9% from the year-ago level but much better than the $7.61 billion most investors thought Philip Morris would produce. Similarly, earnings per share of $1.38 were down 4% from last year, but beat expectations by a nickel per share.
Everywhere you look, though, the damage from the strong dollar is evident. After adjusting its sales figures for currency and the impact of acquisitions, Philip Morris International's revenue climbed 4%. Even more dramatically, the company said unfavorable currency effects hit earnings per share by $0.20, without which EPS growth would have come in at almost 10%.
Source: Philip Morris International.
Because of the severity of the currency headwinds that Philip Morris faces, the tobacco giant revised its full-year 2014 earnings forecast downward. Philip Morris now expects EPS of $4.76 to $4.81, representing an 8% to 10% drop from 2013's EPS of $5.26 and a reduction of about $0.10 to $0.15 from its previous guidance.
Yet CEO Andre Calantzopoulos wasn't downbeat about the results, seeming comfortable that negative currency-related effects will eventually subside. Calantzopoulos noted that "our underlying business momentum is such that we remain confident we are on course to achieve currency-netrual adjusted diluted EPS growth for the full year 2014 of approximately 6.5% to 7.5%." Moreover, he pointed to what he called "robust pricing and solid market share gains" in each of the company's four geographical segments.
A deeper look at Philip Morris International's results
Looking around the world, Philip Morris had very different results in various areas. Latin America and Canada saw some of the biggest hits from currency fluctuations, with dollar-adjusted revenue climbing 1.8% despite a much larger 13.2% gain in currency-neutral terms. Eastern Europe produced the best results, with a 6.5% gain in revenue and currency-neutral growth at more than double that pace. By contrast, Europe and Asia remained relatively weak, with the latter experiencing a double-digit percentage drop in revenue and even having sales fall on a currency-neutral basis. The same trends showed in the operating income numbers as well.
Total cigarette volumes fell by only 0.4%, representing an ongoing slowing in the pace of a longer-term decline. On the other hand, Marlboro sales fell a more dramatic 3.5%, with sales in Japan, Mexico, Italy, and Poland standing out as particularly weak. Given the importance of the premium Marlboro market, Philip Morris investors have to remain concerned about poorer performance there than in other products.
HeatSticks for the iQOS tobacco-heating product. Source: Philip Morris International.
Will reduced-risk products save Philip Morris?
Given the poor prognosis for cigarettes, Philip Morris International's excitement about advances in its reduced-risk products category seems justified. Calantzopolous said that November's expected rollout of its iQOS product, which heats tobacco to produce vapor rather than burning it, "represents one of our greatest growth opportunities." Certainly, the rise in popularity of electronic cigarettes and vapor products points toward at least a short-term chance at grabbing market share and tapping into the new fad, even though analysts differ on whether traditional-cigarette alternatives will gain traction in the long run.
Investors seemed reasonably pleased if not overwhelmed by the results, keeping shares largely unchanged in pre-market trading after the earnings announcement despite substantial weakness in the broader market. Still, Philip Morris will have to make good on its promise of producing growth irrespective of the direction of the dollar in the months and years ahead.
