Marlboro maker Philip Morris International (NYSE: PM) is a leader in tobacco worldwide, but it’s spearheading the move toward reduced-risk products and away from some of its most successful products. Following the company’s most recent earnings report, Philip Morris CEO Andre Calantzopoulos made comments about the results. By looking at them, you can get a better sense of what Philip Morris and its CEO see for the company’s future.
1. Philip Morris is increasingly relying on iQOS
iQOS is performing exceptionally, demonstrating the importance of our investments and our ability to transfer and apply learnings across markets. We estimate that over 4.7 million adult consumers around the world have already stopped smoking and made the change to iQOS.
You can already see the obvious disparity between the ultra-fast growth in reduced-risk product sales and the sluggish performance in the combustible category at Philip Morris. The company is well aware of the regulatory and consumer preference hurdles involved in sustaining its traditional cigarette business, and so comments like this one reflect Philip Morris’ long-term trajectory toward completely eliminating traditional cigarettes as consumers have known them. With strong performance in Japan and encouraging early results elsewhere, iQOS has the potential to become the worldwide leader in alternative products in the years to come.
Image source: Philip Morris.
2. Philip Morris is still optimistic about its U.S. FDA application
We believe the [Tobacco Product Scientific Advisory] committee’s interactions with presenters and its discussion reflected respect for the integrity of our scientific data and our commitment to bring iQOS to the U.S. Although the committee did not agree with some of the specific language related to consumer communications, it confirmed that the evidence supported the statement that switching completely to iQOS significantly reduces exposure to harmful chemicals.
Philip Morris got disappointing news recently in its application with the U.S. Food and Drug Administration to get approval as a modified-risk tobacco product in the U.S. market, as the advisory panel looking at its application voted against some of the claims that Philip Morris had hoped to make with iQOS. Yet even though the committee voted against supporting statements that iQOS reduces risk of smoking-related illnesses or harm from cigarettes, even the single vote of support that it reduces exposure to harmful chemicals was a step in the right direction. Philip Morris now hopes to work with the full FDA, understanding that the advisory panel’s recommendations aren’t binding.
3. Philip Morris finally gets some currency tailwinds
The $0.16 of favorable currency at prevailing exchange rates included in our 2018 guidance is driven primarily by the euro, Russian ruble, and Japanese yen. … This is the first time since 2011 that we enter the new year with guidance that reflects a positive currency impact.
The strong dollar has punished Philip Morris for years, because most of the money the tobacco giant earns overseas comes in the form of foreign currency. When those foreign currencies are weak, they translate into fewer dollars, leaving the company with weaker earnings and revenue numbers. The dollar’s strength began to fade last year, but it didn’t translate into meaningful currency impacts as expected. Philip Morris is more upbeat this year, but it still remains to be seen whether the company will see the conditions it hopes will emerge in 2018.
4. How tax reform affects Philip Morris
For 2018, we expect an effective tax rate of approximately 28%. The difference between this rate and the 21% statutory rate under the new law reflects the fact that PMI operates in markets outside of the U.S. and is driven by three main factors: foreign tax rate differences, the nondeductibility of interest expense, and the partial disallowance of foreign tax credits related to the application of the rules for global intangible low-taxed income.
It’s easy to forget about tax reform for Philip Morris, given that it operates almost entirely overseas. But it is a U.S. company, and so it’s subject to the corporate tax rule changes. The tobacco giant won’t see complete tax relief because of higher rates in some of its foreign jurisdictions. But Philip Morris does think that tax reform will give it more flexibility in repatriating cash at will, and that might help it with future investments.
5. Worries about iQOS cannibalization are overblown
Cannibalization rates are coming down over time as obviously the product becomes more known. If we take Japan or Korea, it attracts smokers that switch to it from different price categories and up-trading.
Investors have been concerned that iQOS would only encourage those who already smoke Philip Morris cigarette products to switch, costing it valuable revenue. But that hasn’t been the company’s experience thus far. In Japan, Philip Morris cited numbers that cannibalization rates are coming down even as the product ramps up more fully. Competing products could change that dynamic, but for now, iQOS is the clear leader in the markets it serves.
Philip Morris is trying to get off to a good start in 2018. Given how important iQOS is to its overall future, the tobacco giant will have to see continued strength in the reduced-risk portfolio’s performance in order to keep investors optimistic going forward.
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