Philip Morris International Inc. — Q3 2017 Form 10-Q
Business context and reporting period. Unaudited results cover the three and nine months ended September 30, 2017, compared with the same 2016 periods. PMI manufactures and sells tobacco and nicotine products outside the United States across four geographic segments. Management plans to reorganize into six reportable segments effective January 1, 2018.
Financial performance
| Metric | Q3 2017 | Q3 2016 | Nine months 2017 | Nine months 2016 |
|---|---|---|---|---|
| Net revenues | $20.638 billion | $19.935 billion | $56.513 billion | $55.764 billion |
| Net revenues excluding excise taxes | $7.473 billion | $6.982 billion | $20.454 billion | $19.714 billion |
| Operating income | $3.068 billion | $2.977 billion | $8.185 billion | $8.203 billion |
| Net earnings attributable to PMI | $1.970 billion | $1.938 billion | $5.341 billion | $5.256 billion |
| Diluted EPS | $1.27 | $1.25 | $3.43 | $3.38 |
| Operating cash flow | Not separately stated | Not separately stated | $5.991 billion | $5.928 billion |
- Excluding excise taxes, revenue increased 7.0% in Q3 and 3.8% year to date. Price increases and favorable volume/mix drove growth, partly offset by currency.
- Operating margin on reported net revenues was approximately 14.9% in Q3 versus 14.9% in Q3 2016, and 14.5% year to date versus 14.7%. Gross margin was approximately 23.0% in both year-to-date periods.
- Year-to-date net cash used in investing was $2.292 billion, including $995 million of capital expenditures; net cash used in financing was $1.232 billion. Dividends paid were $4.854 billion.
- At September 30, cash was $7.667 billion; total debt was approximately $34.0 billion, up from $29.1 billion at year-end 2016. Cash less total debt implies net debt of approximately $26.3 billion. Current assets were $20.859 billion and current liabilities $18.514 billion; stockholders’ deficit was $9.633 billion.
- Committed credit facilities totaled $8.0 billion, fully available, with no facility borrowings. Commercial paper outstanding was $2.3 billion. The leverage covenant ratio was 10.4 to 1.0 against a minimum of 3.5 to 1.0.
Material changes and operating trends
- Q3 shipment volume for cigarettes and heated tobacco units fell 0.5%; year-to-date volume fell 4.9%. Cigarette volume declined 4.1% in Q3 and 7.6% year to date, while heated tobacco unit shipments expanded sharply from a smaller base.
- Reduced-risk product (RRP) net revenues, including excise taxes, rose to $994 million in Q3 from $214 million and to $2.063 billion year to date from $394 million. Asia, particularly Japan, was the primary growth driver.
- Asia operating companies income increased 39.9% in Q3 and 20.3% year to date, supported by heated tobacco growth, pricing and favorable volume/mix. EEMA income fell 20.5% in Q3 and 8.4% year to date; EU income fell 7.0% and 10.1%, respectively. Latin America & Canada income increased 17.9% in Q3 and 4.7% year to date.
- Management attributed volume pressure to market declines, pricing and tax changes, competition and illicit trade. Saudi Arabia’s June 2017 excise-tax change doubled retail prices; cigarette shipments there declined sharply. Q3 Asia shipments benefited from estimated Japan inventory movements of about 2.1 billion units; excluding estimated net inventory movements, total volume fell 1.3%.
Outlook, commentary and risks
- On October 19, 2017, PMI forecast full-year 2017 reported diluted EPS of $4.75–$4.80 at then-prevailing exchange rates, versus $4.48 in 2016. The forecast anticipated net revenue growth excluding excise taxes of more than 7%, excluding currency and acquisitions; it excluded share repurchases.
- Management estimated a full-year 2017 effective tax rate of approximately 28% and capital expenditures of approximately $1.6 billion. Capital spending is supporting RRP and heated-tobacco production capacity expansion.
- Management cited an unfavorable year-to-date currency impact of $0.23 per diluted share; excluding currency, diluted EPS increased 8.3%. A $61 million tax benefit from legal-entity restructuring contributed $0.04 per share.
- PMI expects to support the Foundation for a Smoke-Free World with approximately $80 million annually for 12 years beginning in 2018, depending on the Foundation’s requirements and operations.
- RRP commercialization remains subject to scientific evidence, regulatory approval, consumer adoption and manufacturing capacity. IQOS was available in key cities in 30 markets and nationwide in Japan; device constraints in Japan were expected to ease in early 2018. FDA substantive reviews of PMI’s Platform 1 applications were underway.
- Material risks include extensive tobacco regulation and excise taxes, falling cigarette consumption, illicit trade, foreign-exchange volatility, competition, and litigation and governmental investigations. PMI reported no accrual for pending tobacco-related cases because management did not conclude a loss was probable or estimate a loss range.
- Notable exposures include Quebec class-action judgments under appeal, with PMI’s subsidiary having posted CAD 226 million of security; Thai customs cases seeking fines of approximately $2.43 billion and $596 million; and a South Korean tax assessment paid under appeal of approximately $240 million. Outcomes remain uncertain.
Important facts for investors to verify
- Whether 2017 EPS and revenue guidance was achieved, and how foreign exchange, taxes and operating performance affected the final results.
- Whether RRP revenue growth, consumer conversion, manufacturing capacity and device supply continued as management expected, particularly in Japan.
- Whether falling cigarette volumes, market-share changes, price increases and illicit trade affected segment profitability and cash generation.
- How debt, commercial-paper usage, dividend payments and capital expenditures evolved, and whether credit ratings or covenant headroom changed.
- Developments in Quebec tobacco litigation, Thai investigations and South Korean tax and criminal proceedings, including any changes to potential financial exposure.
- The filing says receivables sales supported operating cash flow: $7.1 billion of receivables were sold during the nine months, with $0.6 billion still outstanding at period end. Assess the effect of this program on reported cash generation.