The global tobacco industry has been exposed to economic slowdowns, higher taxation, and stringent government regulations all over the world, and Philip Morris International (PM +0.99%) is no exception to all this. Philip Morris has had its fair share of problems with declining sales volumes, unfavorable foreign exchange translations, and higher government taxes. Under these circumstances, let's see where Philip Morris is heading.
Higher revenue, declining volume
Recently, Philip Morris International reported mixed quarterly results. First, there was an increase in earnings per share of 4.3%, which stood at $1.44 against $1.38 in the first quarter of last year. Second, revenue also grew 0.1% to $7.93 billion. However, volume slipped 5.7% to 223.1 billion units. This quarter, earnings met Reuters' expectations, which the company had failed to do in the previous quarter.
The company was able to achieve this high revenue only through positive pricing strategy and not through its core business expansion. This raises questions over its future growth as this continuous increase in price is bound to deter the consumers, hence decreasing the overall volume further.
Constant EPS revisions
The company has revised its fiscal year's (2013) EPS guidance downward once again, forecasting it to be in the range of $5.35-$5.40, citing a cautious outlook for European Union and Russia. Sales are forecasted to decrease next year by 7%-8% in the EU and 9%-11% in Russia, as the regional governments are trying to deter smoking through higher excise taxation. Earlier in the year, though, the company revised its EPS guidance upward, estimating it to be in the range of $5.37-$5.42, which is in line with Reuters' expectations. These constant revisions of EPS guidance (twice downwards and once upward) indicate that management is not very sure about Philip Morris' future prospects as its sales volume continues to decline.
Investments
Philip Morris International has recently acquired an additional 20% stake in "Philip Morris Mexico," which will marginally push its revenue upwards. The company has also reached an agreement to acquire 49% interest in Arab Investors TA (AITA). Through this 49% stake, PMI will secure almost 25% economic interest in Société des Tabacs Algéro-Emiratie, a joint venture between AITA and a state-owned Algerian company. This investment is going to enhance PMI's earnings from Algeria, which will be reflective in 2014's results. For the past five years, Algeria has been a key driver of growth of PMI's premium brands. This investment is anticipated to open more doors for additional business opportunities in the region. However, increased bans and higher taxation from governments cannot be ruled out, which will slightly decrease the overall profitability of these investments.
E-cigarette business
Philip Morris International has recognized the electronic cigarette category as its "greatest growth opportunity" and plans to enter its market in 2014. The CEO, Andre Calantzopoulos, mentioned that 2014 is going to be a key investment year for the company as they will invest heavily into research and development to introduce a new line of products called "Reduced Risk," which would cater to growing demand for less harmful smoking alternatives.
It seems that the company is betting heavily on the future popularity and growth of electronic cigarettes. There is no universal consensus that e-cigarettes are less harmful than conventional cigarettes due to a lack of any long term scientific evidence. Moreover, the company hasn't tested its products in the market like other tobacco companies. Hence, this heavy investment may not bear fruit any time soon.
Competitors
Reynolds American (RAI +0.00%) capitalized on the increased demand of smokeless tobacco products, which is evident from an 8.8% increase in profits in the third quarter. The company is benefiting from high pricing and is focusing on its smokeless division. Reynolds has plans to save up on labor cost by reducing its labor force by 10% by the end of 2014. The company has the highest dividend yield but low cash flow and high levels of debt among its peers. This makes the company a riskier investment, as the cash generated through its core operations may not be enough to cover all of its bases.
In its latest quarter, Lorillard (LO +0.00%) posted earnings of $0.83 per share, beating Zacks' expectations by 2.5%. This increase was mainly due to the company's growth in its menthol category, which stood at 0.8%. The growing market share indicates that the future sales and earnings will also be healthy. The company has plans of repurchasing $1 billion worth of shares, out of which it has already bought $458 million. The company has the lowest price to sales ratio as compared to other players in tobacco industry, making it a better investment opportunity. Additionally, the company's stock has grown 33% on a year-to-date basis.
Bottom line
Phillip Morris International's woes continue in the current year. Even though the company posted higher earnings, the earnings did not originate from organic growth of the company; rather they were spurred by increased price mix. Moreover, the company's management does not seem very confident about the future, as they have revised their earnings guidance downward twice within a year.
The company will face declining volume as the governments around the globe become more stringent to deter their population from smoking through bans and higher duties and taxations. Also, the company is heavily placing its bet on the electronic cigarette category as a "growth driver," which I think will not deliver the anticipated results because of a lack of global recognition and universal acceptance. Even if Philip Morris succeeds in the e-cigarette business to some extent, it will not make much of a difference, as its market is much smaller than the conventional cigarette market.
Taking all this into consideration, I believe that Philip Morris International is not a great investment option at this point in time.
