We reiterate our recommendation on Philip Morris International Inc. (PM) based on the weak economic cues that give way to operating and financial leverage risk, high taxes coupled with regulations imposed by governments of several countries.
The company reported second-quarter income from continuing operations of $1.34 per share, surpassing the Zacks Consensus Estimate of $1.21 per share. Philip Morris’ quarterly gross profit expanded 20.4% year over year to $5.4 billion, and operating income increased 19.5% to $6.7 billion in the second quarter of 2011.
Cigarette shipment volume in the quarter increased slightly by 0.1% year over year to 241.2 billion units, primarily due to increase in the shipment volume in Asia by 7.5% driven by double-digit growth in Indonesia, Japan and Korea. However, in the European Union, cigarette shipment volume dropped on a year-over-year basis, predominantly due to lower total markets (mainly in Spain), lower market share (mainly in Poland) and unfavorable distributor inventory movements.
In light of the second quarter results the company also raised fiscal 2011 EPS outlook by $0.15. Phillip Morris now expects earnings between $4.70 and $4.80 for fiscal 2011. The guidance is up by approximately 20% to 22.5% versus $3.92 in 2010.
Phillip Morris stated that approximately $0.10 of increase in the guidance comes on the back of an improvement in its business outlook, driven largely by Japan, and approximately $0.5 reflects favorable currency at prevailing rates.
Philip Morris leverages economies of scale and focuses on cost controls, productivity gains, and manufacturing efficiencies. The company has streamlined the operations center in Switzerland, created more shared service centers, and optimized the supply chain. It also plans additional factory rationalization, including the re-sourcing of production volume from the United States to Europe.
However, cigarettes are subject to substantial taxes. Significant increases in cigarette-related taxes have been proposed and many have been enacted as well. Tax increases have an adverse impact on volume and sales of cigarettes due to lower consumption levels, a shift in sales from manufactured cigarettes to other tobacco products and a shift from the premium price to the mid-price or low-price cigarettes.
In spite of the above difficulties, management continued to enhance shareholder value through share repurchases and dividends. In June 2011, Philip Morris declared a regular quarterly dividend of $0.64 per share.
During the second quarter, the company purchased as many as 22.7 million shares worth $1.5 billion. The company also announced a new $12 billion, three-year share repurchase program and expects to repurchase approximately $5.0 billion going forward.
On the other hand,, governments around the world are imposing restrictions on tobacco companies to reduce smoking in their countries. The Food and Drug Administration in America has passed a ruling that will compel tobacco companies to use scary labels on cigarette packets to drive away customers from smoking. Again, the Australian government has proposed a ban on cigarette-packaging advertisements and expects to seek billions of Australian dollars in financial compensation.
Philip Morris is concerned that plain-packaging will damage its cigarette brands like Marlboro, Longbeach and Alpine and reduce their ability to compete against other brands. Governmental actions that outlaw the use of tobacco products, along with the diminishing social acceptance of smoking, have resulted in declining industry volume in many markets.
Additionally, several retailers and importers have emerged who sell fake versions of the company’s top branded cigarettes. Miami is one of the top three areas and a hotbed of counterfeit cigarettes. Apart from being fake, these cigarettes are far more injurious to health than the originals. As per the lab findings of “The Organized Crime and Corruption Reporting Project” fake cigarettes from China are reported to contain 80% more nicotine and 130% more carbon monoxide, and impurities harmful to health. This kind of trafficking affects the company’s reputation and revenues.
Given the pros and cons, the Zacks Consensus Estimate of earnings for the third quarter of 2011 is currently pegged at $1.24 per share, up from $1.00 in the year-ago quarter, reflecting the ongoing economic volatility. Of the 9 firms covering the stock, none revised their estimates in the last 30 days.
Additionally, the quantitative Zacks Rank for Philip Morris is currently #2, indicating upward directional pressure on the shares over the near term.
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