Philip Morris International Inc. — 2016 Form 10-K
Reporting period: Fiscal year ended December 31, 2016. PMI manufactures and sells cigarettes, other tobacco products, and nicotine products outside the United States across more than 180 markets. The filing is an annual report; fourth-quarter figures are included below for context.
Financial results and liquidity
| Metric | 2016 | 2015 | Change |
|---|---|---|---|
| Net revenues, including excise taxes | $74.953 billion | $73.908 billion | +1.4% |
| Net revenues, excluding excise taxes | $26.685 billion | $26.794 billion | -0.4% |
| Gross profit | $17.294 billion | $17.429 billion | -0.8% |
| Operating income | $10.815 billion | $10.623 billion | +1.8% |
| Net earnings attributable to PMI | $6.967 billion | $6.873 billion | +1.4% |
| Diluted EPS | $4.48 | $4.42 | +1.4% |
| Operating cash flow | $8.077 billion | $7.865 billion | +$212 million |
| Capital expenditures | $1.172 billion | $960 million | +$212 million |
Gross margin was approximately 23.1% of reported net revenues, versus 23.6% in 2015; reported operating margin was approximately 14.4% in both years. These margins use revenue that includes excise taxes. Higher pricing and lower marketing, administration and research costs supported operating income, while unfavorable currency and volume/mix weighed on results. The stronger U.S. dollar reduced diluted EPS by $0.46; excluding that impact, diluted EPS rose 11.8%. Interest expense, net, declined to $891 million from $1.008 billion, and the effective tax rate was 27.9%, versus 28.0%.
At December 31, cash and cash equivalents were $4.239 billion, total debt was $29.067 billion, and long-term debt was $25.851 billion. Current assets were $17.608 billion and current liabilities were $16.467 billion. Stockholders’ deficit was $10.900 billion. PMI reported $8.0 billion of committed revolving credit facilities, fully available with no borrowings at February 13, 2017; commercial paper outstanding was zero. Its debt was primarily fixed-rate, with a 2.8% weighted-average all-in financing cost. Moody’s rated PMI A2 with a stable outlook; S&P and Fitch each rated it A with negative outlooks.
PMI paid $6.378 billion in dividends during 2016 and declared $4.12 per share for the year. Its quarterly dividend was raised to $1.04 per share in the third quarter. The prior share-repurchase authorization expired in 2015; PMI reported no common-stock repurchases under a program in 2016 and said it did not then intend to repurchase shares in 2017.
Material changes and business performance
- Cigarette shipments fell 4.1% to 812.9 billion units; PMI estimated its international market share at 15.3%, down from 15.5% in 2015. OTP shipments declined 4.5% to 32.6 billion cigarette-equivalent units.
- Revenue excluding excise taxes fell $109 million: $1.6 billion of price increases was more than offset by $1.3 billion of unfavorable currency and $450 million of unfavorable volume/mix.
- Operating income increased $192 million, reflecting pricing, reduced costs and the absence of 2015 impairment and exit charges, partly offset by $1.0 billion of unfavorable currency and $692 million of unfavorable volume/mix. PMI recorded no asset impairment or exit costs in 2016, compared with $68 million in 2015.
- Segment operating-company income improved in the EU (+11.7%) and Asia (+10.7%), but declined in EEMA (-11.9%) and Latin America & Canada (-13.5%).
- Reduced-risk products were an expanding business: RRP net revenues excluding excise taxes were $733 million, primarily from Japan. IQOS consumables shipments reached 7.4 billion units, versus 396 million in 2015; PMI reported about 1.4 million adult smokers had converted by year-end.
- Fourth-quarter 2016 net revenues were $19.189 billion, gross profit $4.472 billion, net earnings attributable to PMI $1.711 billion and diluted EPS $1.10. Fourth-quarter 2015 comparatives were $18.371 billion, $4.017 billion, $1.249 billion and $0.80, respectively.
Outlook, commentary and significant risks
PMI forecast 2017 reported diluted EPS of $4.70–$4.85 at exchange rates prevailing when guidance was issued, compared with $4.48 in 2016. It cited an expected unfavorable currency impact of approximately $0.18 per share; excluding that impact, the range represented approximately 9%–12% growth. The forecast anticipated net revenue growth excluding excise taxes above PMI’s 4%–6% annual target, excluding currency and acquisitions, and assumed no 2017 share repurchases. PMI expected 2017 capital expenditures of approximately $1.5 billion, primarily supporting RRP capacity, including IQOS.
- RRP execution and regulation: IQOS demand exceeded supply, and PMI limited device sales in Japan during 2016. It expected year-end installed consumables capacity to rise from about 15 billion units in 2016 to about 50 billion in 2017. Commercial uptake, scientific evidence, regulatory approvals and product claims remain uncertain; RRPs contain nicotine and are not risk-free.
- Litigation: PMI disclosed substantial tobacco-related claims, including Quebec class-action judgments under appeal. It said losses on pending tobacco cases were not considered probable and could not be reasonably estimated, so no estimated loss was accrued. PMI’s subsidiary had been ordered to provide CAD 226 million of security across two Quebec cases; the merits appeals were heard in November 2016.
- Government investigations and tax disputes: Thailand prosecutors sought fines of approximately THB 80.8 billion (about $2.29 billion) in one customs-duty case; a separate case filed in January 2017 sought approximately THB 19.8 billion (about $562 million). PMI’s Thai subsidiary disputes the allegations. In South Korea, the affiliate paid approximately KRW 100 billion (about $85 million) in December 2016 and KRW 118 billion in January 2017 under tax assessments it plans to appeal; additional demands and possible criminal investigation were disclosed.
- Industry and financial risks: The filing highlights declining cigarette consumption, excise-tax increases, down-trading and illicit trade, stringent packaging and marketing restrictions, competition, currency movements, political and economic instability, agricultural supply risks, and potential restrictions on RRPs. PMI’s foreign-exchange exposure contributed materially to reported results.
Most important facts for investors to verify
- Whether reported revenue growth translates into durable growth in revenue excluding excise taxes, given lower cigarette volumes and reliance on price increases.
- IQOS conversion, repeat use, supply expansion, margins and regulatory progress against the 2017 capacity and EPS outlook.
- Developments in the Quebec appeals and the Thai and South Korean tax matters, including potential cash, earnings or liquidity effects.
- Dividend sustainability relative to operating cash flow, capital spending and debt; PMI’s 2016 declared dividends equaled 92% of diluted EPS.
- Foreign-exchange assumptions underlying guidance and the implications of negative S&P and Fitch outlooks.