It's easy to think of a company and its products as being essentially one and the same, especially when you're looking at companies in the consumer goods industry. Tobacco giant Philip Morris International (PM 1.80%) is best known for its Marlboro cigarettes and its iQOS heated-tobacco system, and over the past several quarters, growing concerns about demand for both of its key products have weighed on investor sentiment.
Coming into its third-quarter financial report last week, Philip Morris investors were hoping the tobacco company would be able to find ways to keep its bottom line moving higher. Philip Morris' results were quite strong, but it's essential to understand that the global giant got key contributions from a couple of areas that have nothing to do with product demand -- income taxes and interest expense -- and those areas might not keep supporting its business in the future.
Image source: Philip Morris International.
How Philip Morris fared
Philip Morris International's third-quarter results showed considerable strength from the tobacco giant. Revenue net of excise taxes amounted to $7.50 billion, which was up just 0.4% from year-ago figures but was still much higher than the $7.16 billion that most of those following the stock were expecting to see. Net income of $2.25 billion was up 14% from the third quarter of 2017, and that worked out to earnings of $1.44 per share, easily topping the $1.28-per-share consensus forecast among investors.
Yet Philip Morris' fundamental numbers raised some legitimate fears. Total shipment volume was down 2.1% to 203.7 billion units, but that percentage drop wasn't out of line with what the company has suffered regularly in the recent past. The big problem, though, was in the distribution of those results. Cigarette volume worldwide was off 1.7% to 195.1 billion, but sales of iQOS heated tobacco units plunged 11% to 8.7 billion. That figure is now off by nearly half from the highest point over the past year.
Regionally, Philip Morris International's worst-performing segment by far was the East Asia & Australia division. Total shipment volume was off a whopping 22% from year-ago levels, including a 48% crash in heated tobacco unit sales. Solid gains in the Middle East and Africa and the South and Southeast Asia regions weren't enough to offset that hit.
However, Philip Morris had an explanation for the results. Distributor inventory movements included 6.9 billion heated tobacco units, primarily in the key Japanese market. Without that negative impact, iQOS-related shipments would have been up substantially, and overall companywide shipment volume would have risen 1.1%. Also, adverse currency impacts weighed on Philip Morris, costing it roughly $213 million in revenue and $0.09 per share in earnings.
CEO Andre Calantzopoulos was happy with how the business did. "Our total market share was up by 0.5 and 0.6 [percentage] points in the quarter and year-to-date respectively," Calantzopoulos said, and "in addition, supported by our leading brand portfolio, pricing was strong." The CEO called out both the heated-tobacco and combustible cigarette businesses as playing vital roles in pushing Philip Morris forward.
Can Philip Morris build momentum?
Philip Morris remains extremely optimistic. Between the ongoing expansion of iQOS into areas like the European Union and Russia, the planned rollout of the next-generation iQOS 3 device globally, and rising capacity to support heated-tobacco production, the tobacco giant sees great things ahead. As Calantzopoulos put it, "Our business is showing great momentum, [and] as we enter this year's final quarter, I am confident that the strategies and initiatives we have put in place set the stage for an even better business performance in 2019."
Yet investors shouldn't underestimate the impact that lower taxes and falling interest expense have had on earnings. During the quarter, Philip Morris International's bottom line rose by $277 million. Out of that amount, $121 million came from reductions in income tax provisions resulting in large part from U.S. tax reform. Another $78 million resulted from savings that the company enjoyed in interest expense. That left just $68 million in improvement in operating income -- just over 2% year over year -- and with rising rates and the easing of tailwinds from the late-2017 tax reform package, Philip Morris could have more difficulty producing earnings growth in the near future.
Philip Morris reaffirmed its guidance in currency-neutral terms. The company now expects to earn $4.97 to $5.02 per share. That's up 8% to 9% on an adjusted basis from its 2017 full-year results, and it once again assumes that revenue growth will come in at just 3% for the year. Philip Morris still thinks it can sell 44 billion to 45 billion heated tobacco units, which it still sees as a key element of its success going forward.
Look cautiously at 2019
Philip Morris shareholders were happy with the report, and the stock climbed 5% in the two days following its release. Yet investors have to keep an eye not just on the company's products but also on its internal financial handling to make sure that Philip Morris can sustain the momentum it's built over the course of the year.
