Philip Morris International Inc. — Form 10-Q Summary
Reporting period: Quarter and nine months ended September 30, 2018. The unaudited filing covers PMI’s international tobacco and nicotine-products business, including cigarettes and reduced-risk products (RRPs); PMI does not sell products in the United States. Segment reporting was reorganized into six geographic regions effective January 1, 2018.
Financial performance
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Net revenues | $7.504B | $7.473B | $22.126B | $20.454B |
| Gross profit | $4.886B | $4.738B | $14.149B | $13.023B |
| Operating income | $3.156B | $3.088B | $8.675B | $8.241B |
| Net earnings attributable to PMI | $2.247B | $1.970B | $6.001B | $5.341B |
| Diluted EPS | $1.44 | $1.27 | $3.85 | $3.43 |
| Dividends declared per share | $1.14 | $1.07 | $3.35 | $3.15 |
- Q3 net revenue rose 0.4% as reported; excluding unfavorable currency, it increased 3.3%. Nine-month revenue rose 8.2% as reported and 6.5% excluding favorable currency. Pricing was the principal growth driver; Q3 volume/mix was a headwind.
- Q3 operating income increased 2.2% as reported and 7.6% excluding unfavorable currency. Nine-month operating income increased 5.3% both as reported and excluding currency. Approximate gross and operating margins were 65.1% and 42.1% for Q3, and 63.9% and 39.2% for the nine months, respectively.
- PMI-attributable earnings rose 14.1% in Q3 and 12.4% year to date. Lower interest expense and effective tax rates contributed, alongside operating performance. Effective tax rates were 23.0% in Q3 and 23.3% year to date, versus 28.5% and 27.1% in the comparable 2017 periods.
- RRPs generated $823M of Q3 revenue, down 13.2%, and $2.970B for nine months, up 48.7%. Q3 weakness primarily reflected lower Japanese heated-tobacco-unit shipments associated with distributor inventory movements; nine-month growth reflected wider commercialization.
- Total cigarette and heated tobacco unit shipments declined 2.1% in Q3 and 1.2% year to date. Excluding estimated unfavorable distributor inventory movements, PMI reported increases of 1.1% and 0.3%, respectively. Cigarette shipments fell 1.7% in Q3 and 2.7% year to date; heated tobacco unit shipments fell 11.0% in Q3 but rose 42.4% year to date.
- Operating cash flow was $7.056B for nine months, versus $5.991B; capital expenditures were $1.102B versus $995M. Cash flow less capital expenditures was approximately $5.954B, compared with $4.996B. Financing activities used $7.904B, including $5.110B of dividends paid and repayment of a $2.5B bond.
Financial position and liquidity
- At September 30, 2018, cash and cash equivalents were $5.880B, down from $8.447B at December 31, 2017. Total debt, including short-term borrowings and current maturities, was approximately $31.8B, down from $34.3B. Cash less total debt was approximately negative $25.9B at both dates.
- Current assets were $18.538B and current liabilities $15.599B. PMI reported a total stockholders’ deficit of $9.942B.
- PMI had $8.0B of committed revolving credit facilities fully available and no commercial paper outstanding at quarter-end. The company reported a 10.7-to-1.0 covenant ratio against a minimum of 3.5-to-1.0. Credit-agency outlooks were stable.
- Operating cash flow benefited from receivables sales: cumulative receivables sold were $8.0B in the nine-month period, and $0.6B remained outstanding with financial institutions at quarter-end.
Material changes and management commentary
- Nine-month net revenue growth was led by the European Union, where revenue rose 14.9%, and South & Southeast Asia, up 7.1%. East Asia & Australia operating income fell 11.7% year to date; Middle East & Africa operating income fell 13.3%. Japan distributor inventory movements materially affected reported Q3 volume and revenue.
- Management attributed earnings growth to pricing, lower interest expense and a lower tax rate, partly offset by unfavorable currency, volume/mix in certain markets, and higher spending on RRPs. PMI said the Q3 operating-income benefit from pricing was partly offset by higher manufacturing and RRP marketing costs.
- Argentina was treated as a highly inflationary economy effective July 1, 2018, with the U.S. dollar as the affiliates’ functional currency. PMI said this was included in underlying results and forecast an approximately $0.06 unfavorable full-year EPS currency impact.
- PMI repaid the $2.5B May 2018 bond maturity using existing cash and said it did not intend to repurchase shares in 2018. The quarterly dividend was increased 6.5% to $1.14 per share, an annualized rate of $4.56.
Outlook, risks and contingencies
- On October 18, 2018, PMI reaffirmed 2018 reported diluted EPS guidance of $4.97–$5.02 at then-prevailing exchange rates, implying 28%–29% growth versus 2017 reported EPS of $3.88. Excluding an estimated $0.12 unfavorable currency impact, management cited projected growth of 8%–9% versus 2017 adjusted EPS of $4.72.
- Key forecast assumptions included approximately 2% total cigarette and heated-tobacco shipment-volume decline; 44–45B in-market heated tobacco unit sales and 41–42B shipments; about 3% currency-neutral net revenue growth; approximately 7% combustible-product pricing; roughly $600M of net incremental RRP investment; about $9B operating cash flow; $1.5B capital expenditures; and an approximately 24% effective tax rate. The volume assumption includes an expected full-year distributor inventory reduction of about 3B units, concentrated in Q3 and mainly in Japan.
- PMI’s RRP transition depends on consumer adoption, product performance, supply capacity and regulatory approval. IQOS applications for U.S. premarket and modified-risk authorization remained under FDA review. Management noted that RRP results are less predictable than the mature cigarette business, and that regulations may restrict products, marketing or risk-reduction claims.
- Risks include declining cigarette consumption, excise-tax increases, down-trading and illicit trade; foreign-exchange and tax uncertainty; competition; supply-chain constraints; and extensive regulation. Management’s 2018 tax estimate remained subject to further interpretation of the Tax Cuts and Jobs Act and earnings mix.
- PMI reported pending tobacco litigation, including significant Canadian class-action judgments under appeal. Management said it had not concluded a loss was probable, could not estimate a possible loss or range, and had accrued no estimated loss for pending tobacco-related cases. The filing warns that an adverse outcome could materially affect a particular period.
- Other notable matters include Thai customs-related criminal proceedings and a separate customs assessment matter for which the appeals board revoked all notices of assessment; and South Korean tax assessments that PMI had paid while appealing. Several shareholder class actions were also pending. PMI stated it intended to defend the shareholder suits vigorously.
Important facts for investors to verify
- Whether RRP consumer demand and in-market sales support the shipment, revenue and EPS assumptions, particularly as Japan inventory normalizes.
- Whether the forecasted pricing, volume, currency-neutral revenue growth, operating cash flow and approximately 24% tax rate are achieved.
- How much of reported operating cash flow reflects working-capital movements and receivables sales, and the implications for cash conversion.
- Developments in Canadian tobacco litigation, Thai and South Korean proceedings, and any change to PMI’s assessment or accruals for contingencies.
- Whether RRP regulatory decisions, scientific evidence, product warranties and component-supplier capacity affect commercialization or investment requirements.