Over the past couple of years, Philip Morris International (PM 1.02%) has embraced a monumental change in its long-term philosophy. As cigarette smoking becomes less popular, Philip Morris has turned to alternative products as a path forward for future growth, with the goal of finding ways to reduce or eliminate the dangers of smoking traditional cigarettes while still preserving what its customers want. The commercial success of the iQOS heated-tobacco system has been encouraging, and the comments that CFO Jacek Olczak made following Philip Morris's most recent quarterly financial report reveal a lot about how the company sees itself in the future.
Let's look more closely at some of those comments and what they mean for Philip Morris in the long run.
1. Philip Morris is embracing iQOS wholeheartedly
We have now launched iQOS in key cities in 27 markets globally. ... We are particularly pleased with the early performance in Korea. ... Importantly, we continue to grow the national share of our heated tobacco portfolio sequentially in many of our early launched markets beyond Japan.
Japan was the launching point for iQOS, and the product has become a huge competitor in the island nation, with shipments of HeatSticks accounting for 40% of total shipments from Philip Morris in Japan. Yet investors also have to stay focused on the performance of the product elsewhere. Gains in Italy, Portugal, and Romania have also been noteworthy, and Philip Morris looks forward to fully national rollouts once it resolves capacity constraints by building out HeatSticks production facilities to meet demand.
Image source: Philip Morris.
2. Currency is still a headwind for Philip Morris
The $0.06 increase in the unfavorable currency impact on our guidance as compared to our previous guidance in April is due principally to the depreciation of the Japanese yen and Russian ruble versus the U.S. dollar.
The strength of the dollar has been a big problem for Philip Morris, and investors had come into 2017 hoping that the worst was over for Philip Morris on the currency front. However, that hasn't come to pass. It's true that the euro has strengthened against the dollar, which should help offset some of the losses that Philip Morris has suffered in its European business over the past several years. However, Philip Morris gets a lot of its business from regions that haven't seen the same rebounds in their respective currencies. Investors will therefore have to wait a bit longer before they can see negative impacts to earnings disappear.
3. Philip Morris keeps relying on its pricing power
We recorded a pricing variance of $367 million in the second quarter, supported by all regions. Our year-to-date June pricing variance of $775 million represents 6.1% of first half 2016 net revenues.
To keep its revenue from falling because of sharply lower shipment volumes of traditional cigarettes, Philip Morris has to raise its prices. It can only do so if it has the market power to make those price increases stick. Fortunately, Philip Morris has successfully built up its brands to retain pricing power. Challenges remain in some key markets such as Russia, but overall, Philip Morris has ridden the promotional value of its Marlboro and other brands to help support its business strategy with respect to pricing.
4. Philip Morris is waiting on the FDA
We're waiting for premarket approval authorization with the FDA. And counting just the calendar days, somewhere before the year-end, it should happen.
Philip Morris is hoping to get the U.S. Food and Drug Administration to allow it to sell iQOS products in the U.S., with a partnership with former parent Altria Group (MO -0.49%) calling for Altria to license iQOS from Philip Morris and then sell it in the U.S. market. Olczak sees Altria as being "good to go to launch the product in the U.S." and that everyone is just waiting on the FDA for approval. It's uncertain whether that will happen by the end of 2017, but Philip Morris is hopeful that a quick launch remains a possibility.
5. Earnings guidance is still strong
Our guidance continues to represent a growth rate of approximately 9% to 12% compared to our adjusted diluted earnings per share in 2016.
The hit to earnings related to foreign currencies that Philip Morris suffered was unfortunate, but the company is still optimistic about its core growth prospects. Stronger growth in the second half should come as HeatSticks shipments increase, and investors can expect an increasing share of growth to come from reduced-risk products like iQOS. So far, Philip Morris has pulled a large number of customers from other brands to iQOS, and if that continues, the product should be a huge net positive for Philip Morris.
Philip Morris has had to deal with ongoing obstacles that have prevented it from reaching its full potential. Yet with favorable long-term efforts, Philip Morris has the ability to bounce back and start performing strongly again in the near future.
