Philip Morris recently reported earnings and shares have been in a freefall. The stock fell nearly 18% towards the end of the week. PM is now trading around $84/share down from $120 last summer. This was due to falling cigarette volumes and a perceived slowdown in demand for reduced risk products. On the bright side, the dividend has been pushed to 5%, sweeting the deal for income investors. The question remains, is Philip Morris International really in trouble? Is this stock oversold?
Unlike the past four years, in the current quarter, revenue was up 14% YOY to $6.89 billion. This figure still missed analyst estimates by $100 million. Another concern was how expenses increased as the company marketed its new products. This caused earnings to come in at $1.00/share, down $0.02 from last year. However, for the year, PM and most analysts expect to see over $5.00/share. There is certainly cause for concern, but the sky isn’t necessarily falling. Earnings have remained relatively steady and reduce risk products continue to become a greater share of total revenue.
The main reason earnings failed to meet expectations was because of a 20% increase in the cost of sales. Furthermore, marketing and research costs rose 26% to $1.83 billion. This comes as Philip Morris focuses on heated products and less on traditional combustible cigarettes. These expenses are unfortunate but necessary given the declining volume in cigarette shipments. If PM relied solely on combustible cigarettes the company would most likely be in a perpetual state of decline. However, the development and success of these reduce risk products is very compelling.
Reduced risk products, now account for $1.1 billion, or 16% of revenues. This number is expected to increase substantially in the future, despite a small slowdown in Japan. PM still has numerous geographic markets and age groups to penetrate. PM was highly successful in converting millennial consumers. They’re now tasked with converting older, more conservative smokers. New geographic markets PM is targeting are vast and even include the U.S. If the FDA approves, PM will be able to license iQOS technology through Altria (MO) and begin selling in the U.S. While there is cause for concern, I intend on holding on to PM. Despite some moderate risk there is still tremendous opportunity.
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