Philip Morris International Inc. — Q1 2020 Form 10-Q
Reporting period: Three months ended March 31, 2020; unaudited U.S. GAAP results. PMI manufactures and sells cigarettes and reduced-risk products (RRPs), including IQOS, primarily outside the United States.
Financial results
| Metric | Q1 2020 | Q1 2019 | Change |
|---|---|---|---|
| Net revenues | $7.153 billion | $6.751 billion | +6.0%; +7.1% excluding currency |
| Gross profit / gross margin | $4.751 billion / 66.4% | $4.286 billion / 63.5% | Margin +2.9 percentage points |
| Operating income / operating margin | $2.789 billion / 39.0% | $2.050 billion / 30.4% | Income +36.0% |
| Net earnings attributable to PMI | $1.826 billion | $1.354 billion | +34.9% |
| Diluted EPS | $1.17 | $0.87 | +34.5% |
| Operating cash flow | $1.111 billion | $1.241 billion | Down $130 million |
| Capital expenditures | $170 million | $324 million | Down $154 million |
| Total debt at March 31 | $28.4 billion | $31.0 billion at Dec. 31, 2019 | Down $2.6 billion |
Q1 operating cash flow less capital expenditures was approximately $941 million, versus $917 million a year earlier. Cash and cash equivalents were $3.746 billion at March 31, down from $6.861 billion at year-end. Total current assets were $16.861 billion and current liabilities $16.584 billion. Total liabilities exceeded assets, leaving a stockholders’ deficit of $11.063 billion.
PMI’s effective tax rate was 22.6%, unchanged from Q1 2019. Reported gross and operating margins improved; the reported operating-income comparison benefited substantially from $453 million of Q1 2019 charges related to RBH, Canadian litigation and plant impairment.
Business trends and comparison with prior period
- RRP net revenues rose 25.1% to $1.555 billion; combustible-product net revenues rose 1.6% to $5.598 billion. RRPs represented about 21.7% of net revenues.
- Cigarette shipments fell 4.4% to 157.0 billion units, while heated tobacco unit shipments increased 45.5% to 16.7 billion. Total cigarette and heated tobacco unit shipments declined 1.2%.
- Management estimated distributor inventory movements added approximately 5.4 billion units to shipments. Excluding those movements and the RBH deconsolidation, in-market sales declined 3.7%: cigarettes fell 6.7%, partly offset by 35.6% growth in heated tobacco units. Management expected the favorable inventory impact to reverse in Q2.
- Net revenue growth reflected pricing and heated tobacco volume/mix, partly offset by currency and lower cigarette volume. Currency reduced diluted EPS by $0.13; operations contributed $0.25 of EPS growth.
- Regional results were mixed: EU net revenues rose 17.4%; Eastern Europe rose 36.1%; South & Southeast Asia rose 12.4%; Middle East & Africa fell 5.5%; East Asia & Australia fell 5.0%; and Latin America & Canada fell 31.3%, including the impact of RBH’s deconsolidation.
Liquidity, outlook, risks and unusual items
- COVID-19: PMI reported adequate access to inputs and operational status for most factories, but cigarette facilities representing about 20% of global production capacity were affected by shutdowns or limits. Argentina experienced an out-of-stock situation. Working capital needs increased with inventory buildup and extended customer payment terms.
- COVID-related risks included sharply lower duty-free sales, slower IQOS user acquisition, currency volatility, potential down-trading, and possible supply or distribution disruption. PMI expected new IQOS user acquisition to average around 50% below prior expectations while restrictions remained in place. Management said customer retention and conversion rates were not expected to be significantly affected.
- Management expected approximately $0.8 billion of 2020 capital expenditures, down from the previously disclosed approximately $1.0 billion. It estimated a full-year 2020 effective tax rate of about 23%, excluding a discrete tax event. The filing provides no clear full-year earnings or EPS guidance.
- At quarter-end, PMI had $3.7 billion cash, $1.1 billion commercial paper outstanding and $7.5 billion of committed revolving credit facilities, all available. It repaid $3.6 billion of long-term debt in Q1. The company reported investment-grade ratings with stable outlooks and an 11.7-to-1.0 covenant ratio versus a 3.5-to-1.0 minimum.
- Q1 net earnings included a $78 million pre-tax fair-value loss on equity securities ($62 million after tax). The 2019 comparison included a $239 million RBH deconsolidation loss, a $194 million Canadian litigation charge and $20 million of impairment and exit costs. No impairment or exit-cost charges were recorded in Q1 2020.
- Significant legal exposure remains. Canadian tobacco cases are stayed under RBH’s creditor-protection process; the resolution could materially change the fair value of PMI’s continuing RBH investment. PMI said it could not estimate losses for most pending tobacco litigation and had not accrued amounts where loss was not determined probable and estimable. In April 2020, BAT affiliates filed U.S. patent-infringement and ITC actions seeking damages and restrictions on Platform 1 products; PMI said it would defend the cases.
- Other notable contingencies include Thai customs cases, for which subsidiaries paid fines of approximately $37 million and $4 million and plan to appeal; and South Korean and Russian tax disputes. PMI also identified regulatory, excise-tax, illicit-trade, RRP commercialization, product-supply and foreign-exchange risks.
- PMI declared a Q1 dividend of $1.17 per share; its annualized dividend rate was $4.68. It said it did not presently intend to repurchase shares in 2020.
Important facts for investors to verify
- Whether Q1 shipment growth was pulled forward by COVID-related distributor inventory buildup, and how much reversed in Q2.
- Whether COVID restrictions materially affect duty-free sales, cigarette production, IQOS acquisition and consumer spending beyond management’s initial expectations.
- How much earnings growth persists after adjusting for Q1 2019 one-time charges, unfavorable currency, and the RBH deconsolidation.
- Whether RRP revenue and heated tobacco volumes can sustain growth while cigarette shipments decline, and whether marketing and device costs constrain margins.
- Progress and potential financial consequences of Canadian litigation/CCAA proceedings, BAT’s patent actions and other tax and tobacco-related contingencies.
- Cash generation, working capital, debt repayment capacity and dividend coverage, including the effect of receivable sales and continued access to short-term funding.