Philip Morris International Inc. (PM) Q1 2014 Earnings Report, Transcript and Summary

Good day and welcome to the Philip Morris International First Quarter 2014 Earnings Conference Call. Today's call is scheduled to last about one hour, including remarks by Philip Morris International Management and the question-and-answer session. (Operator Instructions) Media representatives on the call will also be invited to ask questions at the conclusion of questions from the investment community. I will now turn the call over to Mr. Nick Rolli, Vice President of Investor Relations and Financial Communications. Please go ahead, Sir.

Welcome and thank you for joining us. Earlier today, we issued a press release containing detailed information on our 2014 first quarter results. You may access the release on our website at www.pmi.com. During our call today, we'll be talking about results for the first quarter 2014, and comparing them to the same period in 2013, unless otherwise stated. References to PMI volumes are to PMI shipments, industry volume and market shares are PMI estimates based on the latest data available from a number of internal and external sources. Net revenues exclude excise taxes, operating companies' income, or OCI, is defined as operating income excluding general corporate expenses and the amortization of intangibles, plus equity income or loss in unconsolidated subsidiaries net. OCI growth rates are on an adjusted basis, which excludes asset impairment, exit and other costs. Data tables showing adjustments to net revenues and OCI, for currency, asset impairment, exit and other costs, free cash flow calculations and adjustments to earnings per share or EPS, as well as reconciliations to U.S. GAAP measures are at the end of today's webcast slides, which are posted on our website. Today's remarks contain forward-looking statements and projections of future results. I direct your attention to the forward-looking and cautionary statements disclosure in today’s presentation and press release for a review of the various factors that could cause actual results to differ materially from projections or forward-looking statements. It's now my pleasure to introduce Jacek Olczak, our Chief Financial Officer. Jacek?

Thank you, Nick, and welcome ladies and gentlemen. Our business results in the first quarter are in line with the 2014 annual guidance that we shared with you in February. The quarter was impacted by a number of distortions that marked a much better performance at the net revenue and OCI level. Our business fundamentals remain solid and we are making progress in addressing the issues that we highlighted in February. Today we are increasing our reported diluted earnings per share guidance for 2014 at prevailing exchange rate to a range of $5.09 to $5.19, versus $5.26 in 2013. Our revised guidance includes $0.61 of unfavorable currency at prevailing exchange rate, compared to the $0.71 previously disclosed and a $0.03 restructuring charge related to the closure of our manufacturing facility in Australia. We have taken $0.01 of this charge this quarter to cover the cost of employee separation and expect to subsequently incur an estimated $0.02 of additional anticipated restructuring charges. Our 2014 guidance represents a growth rate excluding currency and this restructuring charge of approximately 6% to 8% compared to our adjusted diluted earnings per share of $5.40 in 2013. During the first quarter, cigarette volume declined by 4.4% driven primarily by total industry volume contraction and unfavorable inventory movement. We estimate that absent this inventory distortions, our underlying volume was down by around 2%. Net revenues and adjusted OCI, both excluding currency, declined by 1.6% and 3.1%, respectively. The lower revenues and OCI were attributable to Japan and the Philippines, both of which were also impacted by timing distortions. Net revenues and OCI, excluding these unfavorable distortions, as well as the impact of the change to PMI’s new business structure in Egypt, were essentially stable. Adjusted diluted earnings per share increased by 4.7%, excluding currency. Pricing was the…

Thank you. We will now conduct the question-and-answer portion of the teleconference. (Operator Instructions) Our first question comes from the line of Judy Hong of Goldman Sachs.

Thanks, good morning.

Good morning Judy.

Jacek, just Japan. I'm trying to reconcile the 9% decline in your shipments in the second quarter and the inventory movement that we saw, the market share losses. Can you just bridge sort of that 9% decline for Japan in the quarter? And then as you think about then the upcoming quarter, do we then see some of that benefit? So you actually would see a positive shipment in Japan as you flow through the inventory movement the other way?

Well, we have two things for Japan. One is, as we said, our in-market sales actually for the quarter was about 300 million units higher than the first quarter of last year. This was still a little bit lower participation in the trade purchases ahead of the price increases than our principal competitors and our share panel will be the lower on the reported basis and on a restated or adjusted basis, we think it was flat versus Q4 last year. Our shipment and this is how we recognize the revenue on the market, essentially the purchases by our distributors to Japan, so this is one step lower than the in-market sales and the shipments to the distributor were lower by about 1.3 billion units and this is where the distortions, which we have for Japan. When it comes to the next quarters, I mean although we see the market to go down for the full year in the range of 3% to 3.5%, the question is how much trade we'll need to be stock or unwind the higher purchases which have happened at the end of the last quarter. So, I don't think we should have that magnitude of the inventory adjustment and also obviously there is a function of how our shares is going to develop going forward. I mean so far we see the first two quarters sequentially when our share comes flat. I mean if that obviously would remain for the remaining part of the year, we would have a much less of the distortions on the shipment.

Okay. And just on that note, so the underlying market share performance, Jacek, you sound like you're seeing a little bit of stabilization there and maybe cautiously optimistic that things will improve as the year progresses. Can you just give us some color just in terms of what's driving that confidence at this point?

We're encouraged -- as I said, on an adjusted basis, the share came flat versus Q4. So, this is the first sequential quarters which we have over the last good few quarters when we have not lost share. And Marlboro came relatively strong. L&M and Lark continues to be under pressure. There is a program in place to address the Lark performance. And I think also the Be Marlboro campaign, which we started to roll out in Japan in Q1 of this year will get the very positive response at the consumer level. So, we start the number of parameters or brand attributes which the campaign has helped us to address in the other regions, mainly the European region. We start seeing the same sort of an impact in Japan. Preparedly, when the campaign is rolled out, but this is even more encouraging. So, let's stay cautiously optimistic for the year, but this is still the long way for us to fully stabilize or to return to growth in the Japanese market.

Okay. And then secondly, just on Indonesia, just a market share movement there. You called out unfavorable price points. Can you just talk about what drove that unfavorable price point? And then how you're addressing that issue? And how would you characterize your performance in Indonesia in the context of some of the other markets like Japan or the Philippines where obviously you have had some market share challenges? Is this a little bit more one-off situation, or what do you think about the market share performance in Indonesia and how you think about that going forward?

I think there are two factors which, first of all impacted the total industry, impacting the industry performance. One is some sort of a pressure coming still from the last year, the median removal partially of the fuel subsidies, some pressure on inflation, so it has an impact on the total market, especially on the lower price points. I mean this is what the consumers presumably are most impacted by that pressure from their disposable income. Second thing is the market had an underlying trend of the consumer switching from hand-rolled cigarettes to machine-made cigarettes. Obviously, we present in those segments, but our main brand, Dji Sam Soe, is the hand-made kretek cigarette. That brand sit at premium price point of the segment, actually, it is one of the most expensive brands in the market. The brands we started to sell after the price increases last year as of about mid of last year, the brand price per pack was about IDR12,000 for the pack of 12. So, we crossed at the retail level the stick price of IDR1,000. Other main competitors behind us in terms of the price gap. So, I think it's going to take some time until they will cross the market will cross that price point with another brand. I would expect some moderations in the share pressure in Indonesia in the second half of the year and we just have to be patient. We also are addressing the consumer taste preferences going for the machine -- from the hand-made cigarettes to machine-made by line extending Dji Sam Soe. So, we have two very well -- one very well performing variant and we are coming with the second variant, Dji Sam Soe Magnum, which is a filter kretek machine-made -- machine-made kretek cigarette. So, I think the share, -- I mean overall, I think we can get to the decent share performance, but we have to wait a little bit.

Okay, great. Thank you.

Thank you.

Your next question comes from the line of David Adelman of Morgan Stanley.

Hi, Jacek.

Hi David.

First a broader question, Jacek. So this quarter local currency, OCI was down 3, EPS was up 5. How do you envision the balance of the year unfolding? Clearly the results need to be better than this to hit the full year target.

The OCI, on an ex-currency basis for the full year should be -- should obviously have a positive growth

Right.

Otherwise it will be difficult to get to the 6% to 8% on the EPS level, ex-currency obviously.

Okay. And…

You need to note into this thing that this distortion which we had on a shipment basis this year, I'm sorry in the first quarter, I mean at April 3rd, the pressure on the overall OCI growth. But as I said in my remarks, if I would exclude the distortions which we have had in the first quarter, my revenues and OCI would be flattish -- at least flattish for the quarter on ex-currency basis.

Okay. And then second, Jacek, what are you seeing in the market in Russia now that the price increases are starting to come through at retail?

It's very still early because the prices have started to appear at the retail level around second half of February. I think as in the past we were at the beginning of the price changes in Philip Morris, the competition I can see that the following. There is one competitor, which is slow, but they usually were slow. So I think we need still a few weeks to see the full impact on the market. The market was less than 7%, 6.7% diluted down for the quarter. We still hold the forecast for the full year for the full market to be in a decline rate of 9% to 11%. One thing which we have to watch that the current situation with the ruble having some pressure, GDP growth forecast for Russia is coming a little bit lower than the previous forecast. I mean the whole situation around that region is a little bit -- not extremely helpful, so we just have to see how this going to unfold during the year. But as our forecast for the market is at the 9% to 11% decline, we don't see actually that we should revise anything else in our estimate for the year -- for this year at this stage.

Okay. Thank you.

Thank you.

Our next question comes from the line of Bonnie Herzog of Wells Fargo.

Good morning.

Good morning, Bonnie.

I just have -- my first question a quick follow-on on Japan. Given the expected price increases in the market, how much do you think this will increase the total profit pool? And then do you envision capturing I guess more than your fair share over the next few years?

Well, I can talk about this year, as you know, we have ended up and what I see generally the industry has ended up with price increase which essentially just passed on the VAT increase, so I don't see much of the profit pool enhancement in the market. If you deduct the estimated market decline for the year actually coming slightly negative rather than a positive that's for this year; and I think talking about the outer year would be a clear speculation because we also need to see what is the decision of the government with regards to the planned second step of the sales price increase from 8% to 10%.

Okay. That's fair. And then, my second question is on Marlboro. The volume performance was relatively weak during the quarter. So I guess in light of this, could you talk a little bit about Marlboro 2.0, the next generation brand, and how this might reaccelerate growth for total Marlboro? And then, possibly which markets Marlboro has the most opportunity or upside this year?

Well, we post -- essentially post the test market in a few locations for the Marlboro 2.0 architecture. All tests, all three locations reported very encouraging results. I mean the perception of the Marlboro Red really start changing. This is what the brand needed. We think this is the right thing to do to reinvigorate Marlboro Red and somehow replicated I think a tremendous success which we have achieved with the Marlboro Gold a few years ago when we revamped Marlboro gold. So I think it's overall the move in the right directions. We will be rolling results sequentially in the number of markets. To actually give you a one single out one or group of markets where Marlboro have the best of the potential, if I am looking at the last couple of years Marlboro performance, frankly speaking, Marlboro has the potential in every geography. And I think the Marlboro performance in the Europe against all of this negative macroeconomic trend is just confirming that the brand can serve the very stormy waters irregardless of the situation. The brand is and I think is going to be then in a better shape than it used to be in the past. So I will not volunteer to single one market when a Marlboro would benefit. Obviously, we can talk about the Russia, but Marlboro Russia is more than just the Marlboro architecture, it's the product propositions and a couple of other factors.

Okay. That's helpful. And then, my final question is on your dividend. Given your negative EPS growth this year due primarily, of course, to the currency headwind, could you share with us how you're thinking about your dividend? And then, how comfortable or willing you are to let your payout ratio be above your target 65%?

Well, we're currently above the current ratio -- sorry, the current payout ratio. Listen, the divined, as you know, is the decision of our Board, so I think we need to be patient and wait until the September Board and see what decision the Board will make. What I can say at this stage is that I think we have in every single year since we become independent; we've been rewarding shareholders irregardless of some headwinds which we had on our reported result. And I can't say anything more at this stage, but I think we had a track record of generously rewarding shareholders.

Thank you.

Thank you.

Our next question comes from the line of Chris Growe of Stifel.

Hi. Good morning, Jacek.

Morning, Chris.

Hi. I just had two questions for you. I wanted to ask a little bit more detail on the EU. I just noticed -- and I don't recall seeing this of late -- but that the Marlboro brand was down in the quarter but you had growth in L&M, Chesterfield, the Philip Morris brand, more mid-tier type brands. Was there any change in, sort of the mix, if you will, the product mix in that market, anything that worried you about any kind of trading down in some markets?

No. I think that L&M continues to perform well in all markets. Actually L&M total share and Marlboro share was pretty strong -- came strong in the many markets. You have -- and I think Marlboro actually for the quarter went up by the four times of a point if I'm not mistaken, okay in the segment, in the EU segment. Chesterfield had a bit of acceleration. I think Italy has contributed to that. We had some situation in Italy when the former euro price segment has doubled up was the end of the last year. I mean I have said it in my remarks the tax system in Italy is pretty inefficient. Actually I would characterize it as one of the most inefficient systems within the European Union region. We have entered the segment by repositioning Chesterfield. The brand picked up very nicely, so I think it also contributed to the overall performance of Chesterfield. And I think in other larger market volume-wise when the Chesterfield picked up very nicely, I think recently was Poland, but I don't think it's much of the mix. All brands across the price -- irregardless of the price segment positioning are delivering a very strong share growth.

Okay. Thank you. And I just had a follow-up question for you on the Philippines as well. I guess just to be clear; there was another tax increase at the start of the year. So it seemed like across at least some of your volume, you are absorbing that today? Have you taken pricing may be on Marlboro, but not on Fortune or Jackpot, or one of the lower-priced brands?

No. We have fact that we need to restore the competitiveness and put our grip on all key price points in the market, and this entailed that we have to absorb the tax. And then if Marlboro continues selling at the equivalent of the PHP1 per stick. Fortune, we're now trading I think at the retail at the slightly below the PHP2. And we have much the key brands of Mighty, our key competitor there with the Marlboro and it's always the Jackpot and Champion. And I think this is very much behind our market share performance, but the part of our strategy and we have made it very clear, I believe, as of November or so last year that we need to regain our competitiveness in the market. And one of the key elements of restoring the sort of a level playing field I think also in this market.

I had a related question then which is, you're chasing some of this really low-end volume, very unprofitable, or maybe not at all profitable volume. Is there a view that you could then trade that consumer up in the future, or that you'll benefit if you hold onto that share as prices go higher? Is that the viewpoint, or is it better to manage for profitability given your already high share?

That's exactly the plan.

Okay. Got you. Thanks so much for your time.

Our next question comes from the line of Jon Leinster of UBS.

Hi. Good morning, Jacek.

Good morning.

A couple of questions. First of all, on the underlying volume growth down 2%, which inventory distortions are you including? Because it seemed to me the Philippines is probably the largest swing, is that not included in that sort of underlying 2% down?

No. I think the major would come from Japan. And you will have some movement across the number of the markets. I think there was Russia slightly contributing in the things. Yeah, this would be the main one.

So it doesn't include the impact of the Philippines, which was a sort of positive sort of move?

No.

No. Okay. And the big question on pricing, you mentioned obviously the inventory movements added a lot to pricing in the first quarter of 2013 and that's not going to recur. So could we assume therefore that pricing for 2014 in general, the overall mix, the variance, is likely to prove to be less than 2013?

Well, I think we had very a high pricing variance last year to some extent it’s driven also by the one-off in Bolivia and the Philippines, right? So, that thing will not repeat, if you like, this year. But if I compare apples-to-apples, frankly speaking the pricing variance this year we don’t see why this shouldn’t be in line with our historical average sort of annual pricing variance.

Right. Okay. And usually you make some comment about how much of the pricing you've already got through in terms of the market. Is that something you are prepared to comment on at the moment?

Well, we have now made some advancement versus what we have announced in February. So we’re approaching much higher number, and frankly speaking there wasn’t – we have more advancement in terms of announced and realized pricing than we had in February.

And very quickly, lastly; is there any signs that the Italian government is actually moving on the tax system?

Well, I think the decline in the governmental tax revenues in the last year and a continuing for Q1 is something that I believe makes the government looking more closely, I mean, what have led to the situation. As I said, the system is inefficient. It’s very heavily – most heavily in the European Union scaled towards ad valorem component and many other markets also during the crisis. If you look at Spain to some extent, not fully, but France – I mean, that is typical of high ad valorem markets, they have recognized the weakness of the structure and the system and they have moved ahead. I believe, Italian government will -- is closely looking and they will reach the same conclusion that the more specific component is actually better system also from the revenue, the governmental revenues perspective.

But is there actually a proposal out there for any movement, or is that yet to come?

I think there are some discussions.

Right. Okay. Thank you very much.

Your next question comes from the line of Michael Lavery of CLSA.

Good morning.

Good morning.

Back to Indonesia, I just wanted to try to see if I could clarify a little bit or understand it better. My understanding is that Djarum Super and Gudang Garam International have also hit those same price points. I think it was late in the quarter so obviously it wouldn't have had much impact in these numbers, but just in terms of the outlook for the rest of the year, is the issue that there is a segment shift away from their brands and Dji Sam Soe because of the higher price point, or is it that those two are gaining from you and that you should be able to get some of that back, or how does that work?

Well, I think their price point has –is one of the key elements to play there. As I said, I mean, Dji Sam Soe now, I mean most of the packs sold in the market at 13,000 rupiah per pack of 12. So, I mean, clearly we are well above the 1 rupiah price point and retailers try to even round up that price to 1,500 if not more. While the Djarum and the GG, I think, if I not mistaking, the key brand competing with Dji Sam Soe now still have sums volumes below 12,000 and I would think about the half of the volumes – maybe slightly more than half of the volumes at the 12,000 per pack. So they are just now hitting the sum around price point. I think, the issue is the market when you have a pretty frequent sort of a pricing increase. So I think it’s just a matter of a time when the pressure on the Dji Sam Soe should ease going forward. This is from a price point perspective.

So, just to make sure that I understand that, you are saying some of the competitive pricing is scattered like within the country so that some markets probably in bigger cities have the higher price points but for the competitive brands but it's not everywhere?

Well, I think it is due to the size and the structure of the trade of the country, you don't have the price increases which will hit the retail and consumers in one given point in a time. You have this – you announced the prices, you introduced the prices to the trade and you might at have in a given point, in any given point a coexistence of the prices – two or three different price points per pack and…

Got you, okay.

And as part of the rolling price increases, I mean, you rather work for the average price in the market at the retail level in order to upset the competitors. Now, I thing to add maybe that, you now, historically the Djarum brand and the GG brand, they were also trading or retailing below Dji Sam Soe, right. So there is maybe some element of the price cut, but I believe it is more the element of the one price point of the 12 per pack – 12,000 rupiah per pack, 1,000 per stick.

Well, and so in terms – I guess, it's almost two months now since they have announced those prices and to your point it may have flown through very widely. But have you seen any improvement in your trends on Dji Sam Soe into April so far?

Well, we have been announcing the prices as well, so this is like sort of the moving curve situation, if you like. Right?

Right. Okay.

The market in a given one moment – in a given moment will cross the ones price point. We had a same situation with Dji Sam Soe when the Dji Sam Soe was crossing the 500 rupiah per stick. So it’s not that we have not upselled with Dji Sam Soe that the brand was nicely growing. We are the first ones to cross the round price point, at that time as I said, 500 rupiah per stick. I mean, we get there little bit of the share pressure and then we will recover. So I mean, let’s see how this is going to play this time.

And can you give any sense of what you expect for the second half, or any part of the rest of the year just in terms of what your share position might look like given that it is obviously it came down but it was also down versus 4Q. Do you expect it to stabilize or do you think it might get worse before it picks up again?

Well, I think that we should expect some less of the share pressure moderation or flattening of the share actually towards the second half, or in the second half of this year. Here Philip Morris in Indonesia had a little bit of pressure on the share if you look at the Q3, Q4 last year. Okay. So we planned it grow at a much faster rate until about the mid of the last year than – okay, Dji Sam Soe again crossed this 12,000 price point, we started observing the pressure. I think we need to just let this period somehow lock.

Okay, thanks. That's helpful. Then in Japan you mentioned you have some programs in place, or starting, to become in place on Lark. Can you give a little color on what those are?

I think we will have to stay a little bit of patient until everything is revealed in the market. So when we’re talking about the future programs, I can't actually tell you much more in detail than what in the market that they announced. But obviously there is the things which drives, so the element which drives the market, i.e. innovation, modernization of the product perception, et cetera, I mean, it’s something which is in the books.

Okay. Thanks. And then just lastly, I know you mentioned the next-generation products. Is there any other details you can give us on those?

Not at this stage. I think that the last week of June the Investors Day which we will have here for the investors community is the great opportunity for us to disclose more details, how and when and we’re going to go into the first market. But we are very excited about it.

All right. That sounds great. Thank you.

Thanks.

Our next question comes from line of Owen Bennett of Nomura.

Good morning, guys.

Good morning.

A couple of questions if I may. Firstly, I was just wondering if you could give some more details on what could be perceived as weaker pricing in EU. I mean, what is driving this? Is it the mix in Italy and is this likely to continue into the rest of the year? Secondly, could you please give some more color on the business building initiatives in Brazil? And what these entail exactly and also how your share development is looking in Brazil? Thanks.

Okay. I think the kind of pricing in Euro – I mean, it’s actually Italy, right, because Italy is lacking some prices, as I have said this earlier.

Yes.

That Italy has this significantly inefficient tax system. I mean I was somehow compounded by the fact that it increased the VAT. They have not -- there was no offset on follow on rate. So that puts the pressure on the pricing in the region. As I said, I mean, let's remain hopeful that the government sees what is the driver of the entire -- their revenue is also collection performance and how this going to be addressed. Meanwhile, we concentrated on holding a strong market share. Our share essentially came flat. Marlboro came flat. This is despite the fact that we see some down trading between the medium and the low segment for this full euro price segment. Chesterfield now is the significant player or key player actually in the full euro price segment, so I think we have some grip in the market. But that's essentially what is behind the pricing in euro, which I think I said that we have recently announced the price increase in Germany over €0.20 per pack, so I think this should also change the bigger picture going forward. And when it comes to Brazil, I don't know if you asked the question, I think the market in Brazil for the quarter I remember was about 2.6% down, I think the market was about $17.3 billion. And our market share nicely grew to about 15.7% or I think improved by the 1.4 points -- it was 1.4 points for the quarter I think was our share.

Okay. And just on the business building initiatives, I'm just wondering what that is exactly? Is that significant, or…

As we know we've very much strong focus at in the south of Brazil. And we had a plan of enlarging our presence there. And we are going from the south slowly to the north of Brazil. And this is also attracting volumes up. So step-by-step, I think we're making a very good progress in Brazil as we did however for the last couple of years.

Okay. Great. Thanks very much.

Thank you.

Our next question comes from the line of Michael Felberbaum of the Associated Press.

Hello, Jacek. I had a question on -- you had mentioned in the commentary for France, the growth of E-Vapor products and their impacts on combustible volumes. And I have wondered if you could provide any color on any overall trends you're seeing as far as the impact on volumes and the growth of E-Vapor products?

Yes. I mean the color -- in terms of the color as always at the beginning of last year we observed 2013, we observed that sort of phenomena in Italy and not even a quarter later -- sorry four quarters later the product is actually, or the attractiveness of this product is fading out and there is no volume, no impact on the market. Based on my knowledge of that category I don't see why France shouldn't play the same way. I mean we know what are the negatives, if you like, of e-cigarettes cigarettes in terms of a satisfaction, meeting the consumers' expectations, etcetera. So we now see this in France. As I said, I saw that last year in Italy. I saw it sometime ago in Germany. I saw it sometime ago in Greece. I can start mentioning the market. And essentially the trend is very much being repeated across the country. So it goes for the rapid sort of a growth. It's a lot of -- it confirms that there was an interest. And I think for a good reason the consumer is looking to this alternative, but the product as it is today in the market is not delivering on the consumer expectations.

Thank you.

Thank you.

We've reached the allotted time for questions-and-answers. I will now return the call to Nick Rolli for any additional or closing remarks.

Okay. Well, thank you very much for joining us. That concludes our call today. If you do have any follow-up questions, the Investor Relations team is available. We are currently in Switzerland and we'll be happy to take your follow-up questions. Thank you again, and have a nice day.