Philip Morris International (NYSE: PM) is set to release its Q2 2019 financial results on July 18, 2019, followed by a conference call with analysts. The company is expected to report revenue of $7.42 billion in Q2 2019, marking a decline of about 4% compared to Q2 2018. Lower revenue is likely to be driven by lower volume of cigarette shipments as millennials are shifting from combustible products to e-vapor, falling market share of Marlboro, and currency headwinds, partially offset by increasing sales of the company’s heated tobacco products. Earnings are expected to come in at $1.33 per share in Q2 2019, lower than $1.41 per share in the year-ago period. Lower earnings could primarily be a reflection of a decrease in revenues, Canadian tobacco litigation-related expenses, and the impact of deconsolidation of the Canadian subsidiary Rothmans, Benson & Hedges Inc. under U.S. GAAP.
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A Quick Look At PM’s Key Revenue Sources
PM reported total revenue of $29.6 billion in FY 2018. The primary operating segments are as follows:
Combustible Products: $25.5 billion revenue in 2018 (86% of total revenue). Under this segment, the company predominantly sells American blend cigarette brands, such as Marlboro, L&M, Parliament, Philip Morris, and Chesterfield.
Reduced-Risk Products: $4.1 billion revenue in 2018 (14% of total revenue). Under this segment PM sells its flagship IQOS devices and heated tobacco units
A] Revenue Trend
- Cigarette shipments have been continuously declining over the last four quarters, due to changing consumer preferences as more people are moving toward non-combustible offerings, and unfavorable foreign currency effect.
- We expect this trend to continue in Q2 as well.
- However, on a y-o-y basis, the decline in revenue in Q2 2019 is not expected to be as sharp as the volume decline, as the company would most likely resort to price increase to mitigate the effect of lower shipments.
- Shipments of heated products increased sharply by 20.2% from 9.6 billion units in Q1 2018 to 11.5 billion units in Q1 2019, due to increasing demand for non-combustible options.
- The discounts and promotional offers by the company are expected to drive volume growth in Q2 2019 as well.
- Additionally, Philip Morris’ rising market share for its heated product segment in the EU region, Japan, and Russia could drive its segment revenue growth in the medium-term.
B] Expenses and Profitability Trend
Total expenses are expected to increase on a y-o-y basis in Q2 2019, led by higher raw material and labor costs, litigation-related expenses, partially offset by lower interest expense.
- Cost of Goods Sold: Cost of sales as a % of revenue declined in Q1 2019 compared to the previous year period. We expect the metric to increase slightly (on y-o-y basis) in Q2 2019, driven by an increase in labor and shipping costs, along with higher cost of tobacco leaves.
- Marketing, Administration and Research Cost: This expense has increased over the last three quarters and we expect it to remain at elevated levels in Q2 2019, driven by Canadian tobacco litigation-related expense and loss on deconsolidation of RBH.
- Interest Expense: Interest expense is expected to see a decline on a y-o-y basis in Q2 2019 as the company used its high cash balance to pay off $2.5 billion of its 10-year U.S. bonds in 2018, which, with a coupon of 5.65%, was the most expensive debt instrument on the company’s books.
Net income margin has steadily declined over the last three quarters. We expect margins to shrink further in Q2 2019 due to projection of lower revenue and a rise in total expenses.
Full Year Outlook
- For the full year, we expect net revenue to increase by 1.3% to $30 billion in 2019 from $29.6 billion in 2018, and further by 3.3% to $31 billion in 2020, as sales under the company’s heated tobacco segment are expected to pick up further.
- Additionally, the FDA nod for the IQOS product is likely to boost the company’s top line further in the medium term.
- However, net income margin is expected to remain flat at 26.7% in 2019, due to litigation expenses and deconsolidation losses, partially offset by lower interest and tax outgo, coupled with a gradual phasing out of the discounts on IQOS.
- Margins are expected to rise to 28% in 2020, led by higher revenue and increasing market share of heated tobacco products.
Trefis has a price estimate of $89 per share for the company’s stock. We believe that the recent FDA nod for IQOS would help the company increase its top line and market share in the US. Also, strong company fundamentals, rising market share of its products in major markets, and a higher dividend pay-out would support growth in the stock price.
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