Philip Morris International (NYSE:PM), Altria Group (NYSE:MO), and Universal Corp (NYSE:UVV) have all reported results over the last few weeks. In the case of Altria and Philip Morris in particular, these results fell short of expectations.
Taking a closer look
But things don't look that bad if we dissect the results to try and figure out what's really going on. For example, in the case of Philip Morris, if we strip out unfavorable currency effects, the company's earnings per share for full-year 2013 actually expanded 8.3% year over year. Additionally, management states that on an adjusted basis, and excluding the effect of currency, EPS grew 10%; including the negative impact of currency, non-adjusted EPS only increased 1.7%.
Still, I prefer not to rely on adjusted earnings figures, as accounting methods used to arrive at these figures can be misleading. Nevertheless, it would appear that for the most part, Philip Morris had a strong 2013. Excluding the Philippines, where a government tax hike sent the sales of Philip Morris' cigarettes plummeting and sales of untaxed cigarettes soaring, the volume of cigarettes shipped by Philip Morris during 2013 only declined 2.7%. What is of more importance though, is the volume of Marlboro cigarettes shipped by Philip Morris during the year only declined 1.3%.
Marlboro sales make up the majority of Philip Morris' overall sales, and the cigarettes are by far Philip Morris' most profitable product in terms of gross margin. With sales of Marlboro declining at a slower rate than the company's average, I feel confident in stating that as of yet, Philip Morris' cigarette sales are not really under pressure.
Sales data aside, one thing that interests me the most about Philip Morris' most recent set of earnings is the company's outlook and operating margin.
Margins are important
One of the reasons that big tobacco has been able to remain so profitable during the last few years, despite the sliding volume of cigarettes sold, is due to the fact profit margins have been expanding. Indeed, big tobacco has been able to use rising excise taxes to disguise their own price hikes, which has led to widening margins.
Worryingly, this was not the case during 2013, and Philip Morris' operating margin for full-year 2013 actually declined from 17.8% reported for 2012 to 16.9%. In part, this margin compression was due to higher excise taxes across the board, and for some reason Philip Morris failed to mitigate these increases through price hikes. The average amount of excise tax paid on Philip Morris' sales increased from an average of 59.5% of total revenue in 2012 to 61% for 2013.
Now, this is important because it implies that Philip Morris could be losing control over the pricing of its products; contracting margins are never a good sign, especially when Philip Morris' margins have gone nowhere but up for the past few years.
Still, Philip Morris' outlook appears encouraging. The company expects EPS of $5.83, at the high end of estimates excluding currency effects for full-year 2014. Including currency, EPS is expected to be in the range of $5.02 to $5.12, sadly down from the $5.26 reported for 2013. All in all, unfavorable currency effects are expected to take a total of $0.71 from 2014 earnings. This forecast includes the productivity and cost savings target of $300 million and a share-repurchase target of $4 billion.
Meanwhile Altria, Philip Morris' partner in crime here in the US reported a solid set of full-year 2013 results, showing that without the negative effects of currency, big tobacco is still very much capable of growth and profitability.
Excluding the effect of special items, Altria's 2013 EPS jumped 7.7% year over year to $2.38. Altria's management forecasts that 2014 EPS will be in the range of $2.51 to $2.58 -- implying growth of at least 5% for the year.
Like Philip Morris, Altria also reported a decline in the number of cigarettes shipped; the volume of Marlboros shipped slid 4.3% for the year. However, unlike Philip Morris, Altria's revenue from smokeless products jumped 5.1%, and smokeless operating income increased 7% to slightly more than $1 billion for the year.
Altria's smokeable-products revenue declined 1.6%, but due to an operating margin improvement of 2.4%, the company's operating income from smokeable products ticked up by 2.4%. Ste. Michelle, Altria's wine subsidiary, reported strong growth, with sales jumping 8.6% year over year; a 0.8% increase in margin meant that operating income from wine increased by 13.5%. And let's not forget Altria's income of nearly $1 billion from its investment in SABMiller.
Not just big tobacco
Tobacco company Universal also reported fiscal third-quarter results last week, and these were much better than the company's big-tobacco peers. Universal sources, processes, and sells tobacco as a commodity, so the company is still seeing strong demand for its services. Indeed, the company reported fiscal third-quarter results that showed sales were up 18% and net income was up 9% from the year-ago period.
Furthermore, Universal's management was extremely upbeat about the future, forecasting a strong finish to the year and indicating that 2015 was going to be a stellar year for the company as well. Unlike Philip Morris and Altria, Universal does not have to worry about the impact of excise taxes on its sales, and the company is not overly reliant upon cigarette sales. No, Universal can sell its tobacco as roll your own or cigars, two sectors which have seen strong growth during the past 10 years.
Big tobacco has proven once again that it can continue to grow sales and earnings in an increasingly hostile environment, and management teams continue to remain upbeat about the future. All in all, investors can continue to rely on big tobacco to churn out the profits and cash returns that they are used to.