The tobacco market is slowly shifting to reduced-risk products (RRPs), which continue flooding the market as an alternative to combustible cigarettes. But the companies leading the charge are familiar faces, including Philip Morris International (PM 0.31%), which recently reported its first-quarter 2023 earnings.
Investors saw the company's first full quarter following its acquisition of Swedish Match and a forecast for 2023. The acquisition changes Philip Morris' profile, and will impact its actions for several years. Here is what investors can expect from the stock moving forward.
1. Share repurchases stop, but the dividend won't
Philip Morris spent $16 billion acquiring Swedish Match, which leaves the balance sheet as a top priority, and management knows it. The company is leveraged at a debt-to-EBITDA ratio of 2.9, which isn't high enough to put the company at risk, but will limit Philip Morris' financial flexibility until that comes down a bit.
Additionally, nearly $15 billion in bonds are maturing over the next four years, so investors should expect some refinancing. Interest rates have risen over the past 18 months, so the company's interest expenses could also creep higher.
Management is conserving cash to pay down debt, and already noting that it won't repurchase shares in 2023. Fortunately, investors who own the stock for its hefty dividend need not worry; management emphasized that the dividend will remain and continue growing. The company is forecasting $10 billion to $11 billion in operating profits, which boils to roughly $7.7 billion to $8.7 billion after subtracting capital expenditures (investments into the business) and interest expenses.
The dividend costs Philip Morris about $8 billion annually, so the payout could be tight. Philip Morris is investing $1.3 billion into the business in 2023; a chunk of that is to boost the production of Swedish Match products (Zyn). While management reaffirmed its dividend commitment, investors should expect only a few token raises until there's more breathing room in the financials.
2. Reduced-risk products continue taking over
The entire tobacco industry is chasing reduced-risk products as the future of nicotine. These products are smoke-free and are marketed as less harmful than combustible cigarettes (though some organizations contend these products still pose many health risks).
Philip Morris is seemingly building quite a lead on its competitors. It's developed and grown its IQOS brand of heated tobacco devices for nearly a decade, and acquiring Swedish Match gave it the Zyn brand, the leading nicotine pouch.
Reduced-risk products accounted for about 35% of total revenue in the first quarter, so this emerging product category has become a very impactful part of the business. Fortunately, management has indicated that heated tobacco units (HTUs), the consumable sticks that go into IQOS devices, carry higher margins, so Philip Morris should become more profitable as this category grow.
Additionally, Zyn is off at a break-neck pace under Philip Morris. It shipped 73 million cans in the first quarter, a 46% year-over-year increase, and that growth should only continue as new capacity comes online.
3. Further penetration into the U.S. market
The company's entrance into the U.S. market could be the best growth opportunity. The United States is a very lucrative nicotine market (look at Altria). Zyn and the 2024 arrival of IQOS to the United States essentially represent all potential upside for investors. A year ago, Philip Morris had no U.S. presence outside of a fledgling distribution agreement with Altria.
Today, Zyn is growing volume at nearly 50% (most of its sales are in the United States), and any meaningful addition of U.S. IQOS users would be upside that it never had access to before. Building a significant market presence in the U.S. would not only help growth, but offset some of the currency exchange woes Philip Morris encounters as a U.S. company generating revenue in foreign currencies.
Philip Morris might not be a flashy stock for a few years; the company's in a transition period, and setting itself up to grow IQOS and Zynn in the U.S. and abroad. But over the long term, Philip Morris looks like a potential runaway winner in what could be a reimagined nicotine industry moving forward.
