Philip Morris International (NYSE:PM) set low expectations heading into its fourth quarter but did well enough to garner a slight share-price increase after announcing Q4 results last Thursday. Its full-year adjusted earnings per share of $5.40 came in at the high end of management's guidance. This quarter's results reflect ongoing trends at the company.
Results versus expectations
A stock's price reflects the dollar-weighted expectations of thousands of investors; even a company that has had a poor year relative to past results can be a good investment if the market's expectations are too low. A look back at Philip Morris' Q4 results compared to expectations sheds light on how well the company may do compared to investors' expectations for 2014.
Investors were looking at three key data points heading into Q4 results: cigarette shipment volume, currency headwinds, and share repurchases.
The first data point -- cigarette shipment volume -- came in disappointingly low but nothing outside the realm of expectations. The company reported a 4.3% decline in cigarette shipments during the quarter, but the decline was only 1.3% excluding the Philippines. The Philippines was Philip Morris' most difficult market in 2013 after a massive sin tax -- as much as four times the old tax -- was levied on tobacco products in January 2013. With such a large increase, even the company's premium brands were unable to fully offset unit declines with price hikes.
However, cigarette volume in the Philippines may stabilize soon. Mighty Corporation -- a local cigarette manufacturer in the region -- has allegedly been evading taxes on up to half of its production volume, making it difficult for Philip Morris to compete. However, the local government is instituting new policies and has scheduled hearings to address the issue.
Once Mighty starts paying the full tax on its cigarettes, the pricing environment should favor Philip Morris. As CEO Andre Calantzopoulos noted on the conference call, a higher tax favors premium brands over discount brands because it narrows the price gap between the two. This enables Philip Morris' premium brands to exercise pricing power and add sales volume as consumers decide to pay only a little extra for the better brand.
For the full year, cigarette volume was down 5.1% -- 2.7% excluding the Philippines. However, revenue was down by only 0.5% due to the company's ability to raise prices in most of its markets to offset volume declines. Once the Philippines situation stabilizes, Philip Morris may be able to grow its revenue again.
The second data point -- currency headwinds -- is a volatile component of earnings that is difficult to forecast. Currency headwinds reduced Q4 adjusted earnings by 8%. Management expects significant currency headwinds to persist into 2014. Though exchange rates do not reflect business performance, continued strengthening of the dollar could have long-term adverse effects on Philip Morris' earning power if current trends persist. Investors should keep an eye on exchange rates, especially dollar-euro and dollar-yen rates, to gauge the impact on Philip Morris' earnings.
The final data point -- share repurchases -- is of great importance to long-term shareholders. Philip Morris repurchased 17.2 million shares for $1.5 billion in Q4. The company has now repurchased more than 26% of shares that were outstanding at the time of its spinoff from Altria Group. If it repurchases the same number of shares in 2014 as it did in 2013, there will be 4% fewer shares outstanding at the end of the year. Constant stock repurchases are one reason that Philip Morris' earnings per share continue to increase at a faster pace than its revenue. Without the repurchases and a healthy dividend, the stock would likely trade at a lower multiple of earnings.
Investors can expect cigarette volumes to continue to decline (though perhaps not as sharply as in 2013), currency headwinds to persist, and share repurchases to continue. Philip Morris' fortunes probably will not change until it launches its reduced-risk products, the first of which is due out in the second half of 2014. As a result, 2014's results may look similar to 2013's. Management estimates 2014 earnings per share will be $5.02 to $5.12 at current exchange rates, about 3.6% lower than 2013. Excluding currency impacts, earnings per share should grow 6% to 8% compared to 2013.
There were no surprises in Philip Morris' Q4 earnings report; that's about the best that investors can hope for as countries around the world enact policies that discourage the use of tobacco products. However, Philip Morris' new slate of reduced-risk products will make its quarterly filings must-reads for investors in the quarters ahead.