Philip Morris International Inc. — Q2 2016 Form 10-Q
Reporting period: Three and six months ended June 30, 2016. Unaudited U.S. GAAP statements. PMI manufactures and sells cigarettes, other tobacco and nicotine products in markets outside the United States, organized across four geographic segments.
Financial results and position
| Metric | Q2 2016 | Q2 2015 | Six months 2016 | Six months 2015 |
|---|---|---|---|---|
| Net revenues, including excise taxes | $19.041B | $18.763B | $35.829B | $36.115B |
| Net revenues excluding excise taxes | $6.649B | $6.859B | $12.732B | $13.475B |
| Operating income | $2.753B | $2.892B | $5.226B | $5.763B |
| Net earnings attributable to PMI | $1.788B | $1.887B | $3.318B | $3.682B |
| Diluted EPS | $1.15 | $1.21 | $2.13 | $2.37 |
| Net interest expense | $223M | $259M | $470M | $534M |
- For the first half, reported revenue fell 0.8%; revenue excluding excise taxes fell 5.5%. Operating income declined 9.3%, PMI-attributable earnings declined 9.9%, and diluted EPS declined 10.1%. Management said H1 EPS would have risen 1.7% excluding the $0.28-per-share unfavorable currency impact.
- In Q2, reported revenue rose 1.5%, while revenue excluding excise taxes fell 3.1%. Operating income declined 4.8%, PMI-attributable earnings declined 5.2%, and diluted EPS declined 5.0%. Excluding a $0.08-per-share currency impact, Q2 EPS rose 1.7%.
- Gross profit was $8.272B in H1 versus $8.868B; gross margin was approximately 23.1% versus 24.6%. Q2 gross profit was $4.285B versus $4.481B; gross margin was approximately 22.5% versus 23.9%. Operating margin was approximately 14.6% versus 16.0% for H1 and 14.5% versus 15.4% for Q2.
- H1 operating cash flow was $2.836B, down from $3.300B. Capital expenditures were $480M versus $413M; operating cash flow less capital expenditures was $2.356B versus $2.887B. Investing cash use was $437M and financing cash use was $1.994B. Cash increased $397M to $3.814B.
- At June 30, cash was $3.814B; total debt was approximately $30.0B, up from $28.5B at year-end 2015, including $28.098B long-term debt and $1.871B short-term borrowings/current maturities. Net debt was approximately $26.2B. Current assets of $16.046B exceeded current liabilities of $12.672B; the current ratio was approximately 1.27. PMI reported a stockholders’ deficit of $10.799B.
- PMI declared dividends of $2.04 per share in H1 and paid $3.173B. The annualized dividend rate was $4.08 per share. PMI said it did not plan share repurchases in 2016.
Material changes and operating trends
- H1 cigarette shipment volume fell 3.2% to 405.3B units; Q2 volume fell 4.8% to 209.3B. Management cited declines in EEMA, Asia and Latin America & Canada, partly offset by EU growth. OTP volume also declined: 3.6% in H1 and 9.7% in Q2.
- H1 revenue excluding excise taxes was pressured by $994M unfavorable currency and $365M unfavorable volume/mix, partly offset by $616M in price increases. Operating income was reduced by $571M currency, $496M volume/mix and $149M higher marketing, administration and research costs, partly offset by pricing and lower manufacturing costs.
- Among regions, EU operating companies income increased 2.3% in H1; EEMA fell 17.0%, Asia fell 11.8%, and Latin America & Canada fell 18.4%. The declines reflected currency, volume/mix and, in some regions, higher costs.
- Excise taxes on products increased 2.0% to $23.097B in H1, despite favorable currency effects. Management expects excise taxes to continue increasing in many markets.
- HeatSticks shipments reached 1.6B units in H1 versus 56M a year earlier; Q2 shipments were 1.2B versus 52M. iQOS was present in 10 markets by June 2016, with national coverage in Japan. The Bologna facility began commercial production in Q1; management anticipated capacity constraints through Q1 2017.
Outlook, commentary and risks
- On July 19, PMI revised its 2016 reported diluted EPS forecast to $4.45–$4.55 at prevailing exchange rates then. This included an estimated unfavorable full-year currency impact of approximately $0.40 per share; excluding that impact, the forecast implied 10%–12% growth versus 2015 adjusted EPS of $4.42. Guidance excluded share repurchases, future currency changes, acquisitions, unusual events and unanticipated impairment or exit charges.
- Management estimated a full-year 2016 effective tax rate of approximately 28%. H1’s rate was 28.3%, compared with 29.2% in H1 2015.
- PMI raised $3.536B of long-term debt proceeds in H1 and repaid $2.072B. It had $8.0B of committed revolving credit facilities fully available, no commercial paper outstanding, and a 10.0-to-1.0 covenant EBITDA-to-interest ratio against a 3.5-to-1.0 minimum. S&P and Fitch maintained negative outlooks; Moody’s outlook was stable.
- Foreign exchange, declining cigarette consumption, excise-tax increases, down-trading, illicit trade, competition, regulation and geopolitical conditions remain key risks. PMI stated that no material changes had occurred to the risk factors in its 2015 Form 10-K.
- Tobacco litigation remains a material contingency. PMI had not concluded that an unfavorable outcome was probable or could estimate losses for pending tobacco cases, so it had not accrued estimated losses. In Quebec, courts ordered security of CAD 226M (approximately $173M) across two class actions; PMI’s subsidiary made its third quarterly installment in June 2016, and merits appeals were scheduled to begin in November 2016. Separately, Thailand prosecutors sought a fine of approximately THB 80.8B (about $2.3B) in a customs-duty and excise-tax case; the matter was in pre-trial evidentiary proceedings.
- PMI reported no asset impairment or exit-cost charges in H1 2016. A European restructuring program begun in 2015 was expected to run through 2017, with total pre-tax charges of approximately $93M; $68M had been recorded in 2015 and up to $25M of implementation costs remained.
- Management reported effective disclosure controls and no material change in internal control over financial reporting during the quarter.
Key facts for investors to verify
- Whether the EPS outlook is achieved, particularly given currency exposure and weaker shipment volumes.
- Whether price increases can offset excise-tax growth, volume/mix pressure and ongoing market down-trading.
- Debt growth, dividend funding and the effect of receivables sales on reported operating cash flow: H1 receivables sold totaled $4.5B, with $1.0B still outstanding at June 30, versus $0.7B sold and $0.1B outstanding a year earlier.
- Progress and economics of iQOS/HeatSticks, including manufacturing capacity, regulatory approvals and the scientific basis and authorization for any reduced-risk claims.
- Developments in the Quebec appeals and security payments, the Thailand prosecution, and other tobacco litigation and tax examinations.