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5 Things Philip Morris Management Wants You to Know

By Dan Caplinger - May 13, 2016 at 10:40AM

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The tobacco company is working hard to keep itself growing.

Image source: Philip Morris International.

The first-quarter financial report from Philip Morris International (PM -0.18%) showed continuing declines in sales and earnings. Much of the drop came from the strength of the U.S. dollar, but some investors are worried that other factors might be at play that could threaten Philip Morris' long-term prospects. Following the report, CFO Jacek Olczak discussed some key topics. Let's take a closer look at his comments.

1. Philip Morris faces tough comparisons

Our first-quarter results ... were heavily affected by a difficult comparison versus our exceptionally strong first-quarter results in 2015 that masked otherwise solid performance.

The Wall Street obsession with year-over-year comparisons presents challenges at times, and Philip Morris suffered from that phenomenon this year. Organic cigarette volume fell 1.4%, and weakness in Asia had a major role. But in part, the drop was because volume had risen by the same 1.4% amount in the first quarter of 2015. More important, although Philip Morris expects declines of 1% to 1.5% for the full year, that's a full percentage point better than forecasts for the entire industry. That shows the company expects to gain market share, which is essential for its long-term success.

2. Pricing is still driving growth

During the quarter, we announced or implemented price increases in a number of markets, notably Argentina, Germany, Indonesia, and Russia.

Keeping prices rising is the best way to sustain revenue growth when volume declines, and Philip Morris continued moving in that direction in the first quarter. The company said that the moves created a pricing variance of $272 million during the quarter. Results in the European Union, Latin America & Canada, and EEMA regions saw especially strong impacts. But even the Asian market, which faced especially difficult comparisons, trends were favorable. Philip Morris expects pricing variances this year to total about 6% of 2015's final revenue figure.

3. The iQOS rollout continues

We are progressing well with the commercializations of iQOS in the EU region. In Switzerland, iQOS is currently present in six key cities, representing approximately one-third of total cigarette industry volume.

Heat-not-burn technology is the cornerstone of Philip Morris International's reduced-risk product line, and for a while now, the company has been rolling out HeatStick products in several areas. In the Swiss market, French-speaking areas are seeing the greatest market-share rates of almost 2%. Numbers in Italy are more subdued, but with new versions of the iQOS product, Philip Morris is refocusing its marketing to try to improve results. In particular, complementing the iQOS flagship store idea with what the company calls "iQOS embassies" should increase distribution of the product going forward.

4. Free cash flow should hold up

We remain focused on generating strong free cash flow and continue to forecast full-year 2016 free cash flow to be broadly in line with last year's level.

Ensuring that Philip Morris generates enough cash flow is the key for shareholders who want sustained dividend growth from their stock holdings. Recent decisions to suspend buybacks and reduce the growth rate of the dividend reflect currency pressures and their impact on free cash flow. News that free cash flow should stay stable isn't as good as free cash flow growth, but it acknowledges the difficulties the company faces and sets a baseline for further improvement.

5. Australia might stop holding Philip Morris back

I'm getting very cautiously more optimistic on Australia, but it's still some time to go. I think that the worst is definitely far behind us.

Plain-packaging regulations in Australia have hurt Philip Morris along with the rest of the industry, but some of the impacts haven't been as bad as many had feared. For instance, Philip Morris actually managed to improve its market share in Australia, which runs counter to the thoughts that packaging uniformity would hurt brand awareness. Growth potential in the deep-discount segment and efforts to increase prices should add up to bring at least a minor uptick to the hard-hit Australian part of Philip Morris' business.

Philip Morris stock is still near all-time highs, and despite some concerns, the tobacco giant is performing very well. That's the result of strong management and handling of finances that bodes well for Philip Morris' long-term future.

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