Philip Morris International Inc. (PM Quick QuotePM - Free Report) appears well-poised with its strong pricing power and focus on reduced risk products (RRPs) amid rising cost concerns and soft cigarette volumes.

For 2022, the company expects proforma adjusted net revenues to increase by nearly 6.5-8% on an organic basis (compared with 6-8% before). The proforma adjusted EPS, excluding currency impacts, is expected to increase 10-12% to the $6.09-$6.20 range in 2022.

Let’s delve deeper.

Factors Backing Philip Morris

Serious health hazards due to cigarette smoking have pushed consumers toward RRPs. The company is progressing well with its business transformation, with smoke-free products generating more than 30% of the company’s net revenues in the third quarter of 2022.

Philip Morris is well-placed toward becoming a majority smoke-free company by 2025. To this end, the company’s IQOS, a heat-not-burn device, counts among one of the leading RRPs in the industry.

In the United States, the IQOS was launched in 2019 through a commercial deal with Altria. The deal was approved by the U.S. Food and Drug Administration.

However, on Oct 20, 2022, Philip Morris reached a deal with Altria to cease their commercial association related to IQOS in the United States as of Apr 30, 2024. After this date, PM will have total rights to commercialize IQOS in the United States. For this deal, Philip Morris will pay a total cash consideration of $2.7 billion to Altria.

In the third quarter of 2022, revenues from RRPs jumped 12.9% to $2,362 million. In the quarter, the company witnessed continued strength in IQOS performance. IQOS ILUMA continued to generate solid results across launch markets.

Management expects solid prospects from IQOS in the future. As of Sep 30, 2022, the company is estimated to have roughly 19.5 million IQOS users on a pro-forma basis, reflecting growth of 22% year over year.

Philip Morris has been benefiting from its strong pricing power. This has helped the company stay firm, even amid soft cigarette shipment volumes and times of higher taxes.

Though higher pricing might lead to a possible decline in cigarette consumption, it is seen that smokers tend to absorb price increases due to the addictive quality of cigarettes. Higher pricing variance was an upside to the company’s performance across most regions in the third quarter of 2022.

Hurdles

Cigarette volumes, in general, have been affected by consumers’ rising health consciousness and a shift to low-risk tobacco alternatives. In the third quarter of 2022, cigarette shipment volumes dropped 1.7% to around 162 billion units. In 2022, the total international industry volume growth (proforma basis) is estimated between flat and an increase of 1%, excluding China and the United States.

PM has been battling cost-related headwinds for a while now. In the third quarter of 2022, the proforma adjusted operating income margin fell 1 point on an organic basis. The decline can be attributed to investments related to expanding IQOS ILUMA, the elevated initial cost of ILUMA devices and related heated tobacco units or HTUs, supply-chain constraints (mainly due to the Ukraine war) and global cost inflation.

In 2022, the proforma adjusted operating margin growth on an organic basis is likely to come in the range of a decline of 50 basis points (bps) to flat (compared with flat to an increase of 50 bps expected earlier).

The gross margin is expected to be lower due to a considerable rise in IQOS device volumes (with supply restrictions easing), the increased initial cost of IQOS ILUMA, elevated logistic costs, growth-oriented investments in the smoke-free space, raw material and energy cost inflation and incremental supply-chain costs.

However, the hurdles are likely to be partially compensated by a continued product mix shift from cigarettes to smoke-free products. Pricing power and strength in RRPs are likely to keep Philip Morris on its growth track.

Shares of this Zacks Rank #3 (Hold) company have climbed 10.3% in the past three months compared with the industry’s growth of 7.9%.

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