Philip Morris International Inc. quarterly report, Q2 FY2023

Business context and reporting period

Philip Morris International Inc. (PMI) filed this unaudited Form 10-Q for the quarter and six months ended June 30, 2023. PMI sells cigarettes and smoke-free products internationally and is pursuing a transition toward a smoke-free portfolio. Swedish Match, acquired in November 2022, is consolidated in results for 2023 but not the comparable 2022 periods, affecting year-over-year comparisons.

Key financial results

Q2 reported revenue rose 14.5%; revenue excluding currency and acquisitions increased 10.5%. Six-month reported revenue rose 9.0%, or 6.3% excluding currency and acquisitions. Revenue growth reflected pricing and higher heated-tobacco volume, partly offset by lower cigarette volume and unfavorable product mix. Smoke-free revenue was $3.177 billion in Q2 and $5.973 billion for the six months, up 34.1% and 24.1%, respectively.

Profitability weakened: Q2 operating margin was approximately 28.6% versus 39.0% a year earlier; six-month operating margin was approximately 31.2% versus 40.8%. Gross margin was approximately 64.0% for Q2 versus 66.2%, and 63.1% for the six months versus 66.3%. Reported results included significant charges described below.

At June 30, cash and cash equivalents were $3.492 billion. Total debt was $47.9 billion, compared with $43.1 billion at year-end 2022; current and long-term debt on the balance sheet totaled $47.893 billion. Net debt using reported cash was approximately $44.4 billion. PMI had $6.3 billion of committed revolving credit facilities fully available and $4.0 billion of commercial paper outstanding. Total stockholders’ deficit was $7.960 billion.

Material changes versus the prior comparable period

• Q2 net earnings attributable to PMI fell 29.8% and diluted EPS fell 29.4%; for the first half, PMI-attributable earnings declined 21.9% and diluted EPS declined 21.8%.
• Q2 and first-half operating income included a $680 million non-cash impairment of Wellness and Healthcare goodwill and intangibles. The segment’s first-half operating loss was $771 million, versus a $65 million loss a year earlier.
• Q2 included a $204 million non-cash South Korea indirect-tax charge following a July 13, 2023 Supreme Court ruling. The amount reflects taxes previously paid.
• Interest expense, net, rose 88.2% to $527 million for the six months, primarily due to debt associated with the Swedish Match acquisition.
• Operating cash flow decreased by $2.155 billion year over year, primarily from higher working-capital requirements and unfavorable currency movements.
• Smoke-free performance benefited from growth in heated tobacco and the inclusion of Swedish Match. First-half cigarette shipments declined 1.7%, while heated tobacco unit shipments rose 18.5%.

Outlook, commentary, risks and unusual items

Management expects 2023 operating cash flow of $10–$11 billion at prevailing exchange rates, subject to year-end working capital; capital expenditures of approximately $1.3 billion; and a full-year effective tax rate of 20.5%–21.5%, excluding discrete tax events. PMI expects international cigarette and heated-tobacco industry volume, excluding China and the U.S., to decline 0.5%–1.5%. It forecasts PMI cigarette and heated-tobacco shipments to grow up to 1%, with heated tobacco shipments of 125–130 billion units and cigarette shipments down approximately 1.5%–2.5%.

PMI expects Wellness and Healthcare revenue of around $300 million in 2023. The unsuccessful inhalable-aspirin clinical study and slower-than-expected contract development and manufacturing growth delayed its ambition to exceed $1 billion of segment revenue in 2025; management expects reduced investment behind the segment next year. PMI cited more than $500 million of aggregate inflationary impact expected for full-year 2023, which it expects pricing, productivity and other mitigation to significantly offset.

Other notable items include $109 million of e-vapor manufacturing restructuring and exit costs; an $80 million first-quarter reduction in revenue related to terminating a Middle East distribution arrangement; and a $1.7 billion payment plus interest to Altria on July 14, 2023, completing the $2.7 billion agreement for PMI to regain U.S. IQOS commercialization rights effective May 1, 2024.

Risks include tobacco regulation, excise taxes, litigation, currency and inflation exposure, and the uncertain adoption and regulatory treatment of smoke-free products. PMI reported approximately $2.4 billion of assets in Russia, including $561 million of cash primarily held in local currency, and approximately $497 million of assets in Ukraine. Russian divestment constraints, sanctions and the ongoing war may affect operations, cash access and asset values; Ukraine’s Kharkiv factory remains suspended. Management stated these developments have and may continue to materially adversely affect the business. Tobacco-related litigation remains extensive; management generally had not concluded losses were probable and estimable, so no general accrual was recorded for pending tobacco cases. The Canadian litigation stay was extended through September 29, 2023.

Important facts for investors to verify

• Track smoke-free revenue, heated-tobacco and nicotine-pouch growth, and comparable results excluding Swedish Match acquisition effects.
• Assess the drivers of operating margin and cash-flow declines, including working capital, inflation, currency, and acquisition-related interest costs.
• Monitor final Swedish Match purchase accounting, including the preliminary valuation and impairment assumptions, and the Wellness and Healthcare business outlook following the clinical setback.
• Follow the South Korea tax litigation and any further consequences of the July 2023 ruling, as well as material tobacco litigation and tax contingencies.
• Evaluate debt refinancing needs, commercial-paper exposure, dividend commitments, and the company’s ability to deliver its cash-flow and capital-expenditure outlook.
• Monitor regulatory changes, product authorizations and patent disputes affecting IQOS and other smoke-free products, including PMI’s planned U.S. IQOS rights transition in 2024.