Philip Morris International (NYSE:PM) is going through an unprecedented period in its history. Having decided that traditional cigarettes don't really have a future in a world that has seen dramatic and consistent declines in smoking over the past several decades, the tobacco giant has instead looked to alternatives that it believes can drive growth in the years to come.
One of the most promising such products has been its IQOS heated-tobacco system, which Philip Morris claims has health advantages over smoking combustible tobacco. Yet a tough period for IQOS created some doubt about whether Philip Morris had made a losing bet on the cigarette alternative.
Coming into its first-quarter financial report in mid-April, Philip Morris investors had wanted to see signs that the company's long-term strategy could in fact produce growth. The results showed some signs of life in overcoming some strong headwinds, and some now see Philip Morris as having regained its momentum for 2019 and beyond.
How Philip Morris fared
Philip Morris International's first-quarter results were encouraging. Revenue net of excise taxes was down 2% to $6.75 billion, but that was a bit better than the slightly larger drop that investors were generally expecting. Similarly, although net income attributable to Philip Morris was down 13% to $1.35 billion, adjusted earnings of $1.09 per share climbed 9% from year-ago levels and topped the consensus forecast for $1 per share among those following the stock.
Foreign currency headwinds returned as a significant detractor from Philip Morris' performance during the period. The company said that the strong dollar took $0.06 per share off the bottom line and worked out to $369 million in downward pressure on revenue. On a currency-neutral basis, Philip Morris would've seen net revenue rise more than 3% versus year-earlier sales.
Philip Morris got a nice boost from favorable volume trends. Total shipment volume of 175.8 billion units was up 1.1%. Cigarette shipments in particular were roughly flat from year-earlier numbers at 164.3 billion units, but IQOS heated-tobacco units shipped saw a 20% rise to 11.5 billion units. Yet that news wasn't entirely good, as Philip Morris got its IQOS success mostly from huge gains in European sales. In the East Asia and Australia segment, which includes the key Japanese market, IQOS volume was down 6.7%, and a big drop in cigarette volumes in that region made it the worst performer across Philip Morris' geographical reach. Some adverse distributor inventory movements of heated-tobacco units also weighed on reported volume gains.
CEO Andre Calantzopoulos was happy to announce that IQOS had reached the 10 million user mark during the period. "Our first-quarter results represent a promising start to the year," Calantzopoulos said, "underpinned by a robust performance from our combustible portfolio and strong share growth from our smoke-free products, notably in Japan, Russia, and across the [European Union]."
Can Philip Morris heat up from here?
Philip Morris thinks that the first quarter was a good start to 2019. As the CEO put it, "This is an encouraging performance and puts us on track to deliver against our full-year adjusted diluted EPS currency-neutral growth forecast of at least 8% on a like-for-like basis."
However, an accounting move forced it to make changes to its guidance for 2019. The company had to deconsolidate its Canadian Rothmans, Benson & Hedges subsidiary, removing its earnings from the parent company's overall results. That pulled Philip Morris' overall earnings projections down to $4.87 per share. Even after accounting for the deconsolidation and other factors, adjusted earnings of $5.23 per share would still be well below what the company was looking to see three months ago.
IQOS has a lot of room left to grow, and Philip Morris will have to work hard to make a transition away from its conventional products. Even after the solid gains for the heated-tobacco system, IQOS sales make up just 2 percentage points of Philip Morris' international 28.4% market share excluding the U.S. and China. It's clear that despite its best intentions, Philip Morris will need a lot of time -- and plenty of further growth in promoting IQOS and similar alternatives -- to make cigarette sales an insignificant part of its overall business.