iQOS’ Impressive Growth Story Continues In The Fourth Quarter For Philip Morris

Philip Morris International (NYSE:PM) reported its fourth quarter and full year 2016 earnings on February 2, 2017. While the company missed consensus estimates on earnings per share by a penny, the metric increased almost 36% in the quarter, primarily attributable to higher sales. Excluding the negative currency impact, the earnings soared 52% year on year. Net revenue was up by 9.1%, outpacing the consensus estimates by 4.5%, driven by higher sales in Asia and the European Union. Cigarette shipment volume fell by 4.4%, stemming from a shift away from tobacco products, as well as a decline in market share. While traditional cigarettes continue to see weak demand, the company has reported impressive growth in its ‘heat-not-burn’ products. It shipped 3.7 billion HeatSticks, compared to 62 million in the same quarter last year.

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Challenges In 2016

The company has had to face a number of challenges in the past year. A significant excise tax hike in Argentina, that drove a more than 50% increase in average industry retail prices, resulted in a decline in the total estimated cigarette market of 11.6%. Furthermore, a shift to super-low priced cigarettes, coupled with the industry decline, resulted in a market share decline for Philip Morris. Moreover, a surge in illicit trade in Pakistan, and a decline in the industry volume in the Philippines and Thailand, also had an adverse effect on the volume and net revenue. However, due to the low margins in these regions, there was a limited impact on the adjusted OCI (Operating Companies Income).

A portion of the cigarette volume decline was also due to the effect of cannibalization from in-switching to HeatSticks, a trend that is expected to continue going forward. The cigarette market share overall, excluding China and the US, declined by 0.6 points in 2016, with low-price Fortune and super-low price Jackpot, both in the Philippines, accounting for 0.5 points of the total decline.

Impressive Performance Of iQOS

Strong performance of the company’s reduced risk portfolio (RRPs), notably HeatSticks and iQOS devices, helped push the company’s growth. Approximately 22% of the RRP net revenue of $733 million in 2016 was attained from iQOS devices, which, however, yielded a negative margin due to introductory discounts offered in the initial commercialization phase to accelerate adult smoker switching. The HeatSticks volume reached 7.4 billion units in the year, which reflected the maximum manufacturing capacity of the company. The volume would have trended even higher without the capacity restrictions, which forced the company to limit the iQOS device sales in Japan since June.

The growth of RRPs had a notable impact on the cigarette industry volume in Japan, which declined 4.6% for the full year, and by 7.4% in the fourth quarter. The market share of HeatSticks continued to expand, and carried on its strong sequential growth, reaching 4.9% in the fourth quarter. Furthermore, in the final week of December, the national market share touched an estimated 5.5%, and its off-take (select C-store sales volume as a percent of total sales volume for cigarettes and HeatSticks) share increased to 7%. The rate of in-switching to HeatSticks from the company’s other brands declined as the year progressed, to an estimated 32% in late 2016.

Globally, as well, the product has performed favorably, serving as an indicator of the future potential of iQOS. Conversion rates of iQOS purchasers, who have fully or predominantly converted to the product, have grown over time, and stood at approximately 70% at the end of 2016. As of year-end 2016, the company estimates that approximately 1.4 million adult consumers have quit cigarettes and converted to iQOS. Moreover, during the fourth quarter, estimated off-take volume in all markets, with launches prior to mid-year, grew at a compound weekly rate of over 6%, comparable to Japan in the initial launch phase. This trend bodes well for the future national expansions, since in Japan, it resulted in an accelerated growth.

Till date, iQOS has been launched in key cities in 20 markets globally, with aims to expand nationally in many of these markets this year. The company is also targeting additional launches in 10 to 15 markets by year end, subject to capacity. Currently the company has 15 billion units of installed annual HeatSticks capacity, and expects an average of 32 billion units in total capacity to be available for commercialization this year. The company anticipates an installed annual capacity of approximately 50 billion units by year-end.

FY 2017 Guidance

The reported diluted EPS guidance for 2017, at prevailing exchange rates, is a range of $4.70 to $4.85, as compared to $4.48 in 2016, and includes an unfavorable currency impact of approximately $0.18. This guidance reflects a growth rate of between 9% and 12%, excluding currency. Currency-neutral financial growth is expected to be skewed towards the second half of 2017, reflecting the timing of HeatSticks capacity and phasing of RRP investments, as well as unfavorable cigarette industry volume comparisons with the first half of 2016, notably in Argentina, the EU region, and Turkey. The advent of RRPs offers an attractive growth opportunity for the company; however, given the emerging nature of the category, the company has widened its EPS guidance rates this year to $0.15. The guidance represents a growth rate that is higher than the target range of 4% to 6% for the company. This is driven by higher RRP volume, primarily HeatSticks and iQOS devices, as well as a favorable pricing variance, of approximately 6% of the 2016 net revenues.

Have more questions on Philip Morris? See the links below:

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• How Will A Ban On Foreign Tobacco Investment In India Affect Philip Morris?
• EU Comes Up With A Plan To Prevent Illicit Cigarette Trade
• Is Japan The New Battleground For Tobacco Firms?
• Forecasting An End Of Cigarettes, Philip Morris Launches iQOS In The UK
• BAT’s Possible Acquisition Of Reynolds To Shake Up The Tobacco Industry
• Philip Morris Q3 2016: Flat Earnings Driven By Shipment Volume Decline
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• Philip Morris Disappoints Investors With Its Dividend Hike
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• Can iQOS Be A Key Growth Driver For Philip Morris In The Future?
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• How Will Philip Morris Perform In Q2 2016?
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• What Is The State Of The Illicit Cigarette Market In The European Union?
• How Will The Brexit Impact Philip Morris?
• What Effect Will The Plain Packaging Ruling In Canada Have On Philip Morris?
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• How Did Philip Morris Perform In Russia, Given The Currency Headwinds And Excise Tax Rise?
• How Has Philip Morris Fared In Comparison To Its Peers?
• How Will Philip Morris’ Revenue And EBITDA Change In The Next 3 Years?
• Philip Morris: Year 2015 In Review
• What is Philip Morris’ Fundamental Value Based On Expected 2016 Results?
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