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Phillip Morris Troubled by COVID-Related Woes & Pricing Aids

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Philip Morris International Inc. (PM - Free Report) has been troubled by soft cigarette volumes for a while now, with the trend continuing in first-quarter 2020. Also, in its first-quarter earnings call, the company warned that coronavirus woes will have detrimental impacts on its 2020 performance and largely impact the second-quarter performance. Nonetheless, Phillip Morris has been focused on expanding in the reduced risk products (RRP) space in the face of receding cigarette volumes due to rising health consciousness and government regulations. Further, this Zacks Rank #3 (Hold) company’s pricing initiatives are worth noting. Let’s delve deeper.

What’s Troubling Phillip Morris?

In its first-quarter earnings call, Phillip Morris notified that it expects lower duty-free sales, on account of travel restrictions stemming from coronavirus, to weigh on its performance. Also, with regard to the IQOS user acquisition, the company is unable to engage with adult smokers through sales forces and retail touchpoints due to restrictions associated with the lockdown. Though the company is utilizing digital tools, it expects the rate of new IQOS user acquisition to decline. Further, the delay in the enforcement of minimum price in Indonesia due to the coronavirus-led restrictions is likely to affect the business. Apart from this, soft consumer spending resulting from unemployment may disrupt market dynamics for a temporary period.

Phillip Morris was anyway expecting a soft second-quarter show due to tough year-over-year comparisons, certain costs and unfavorable dynamics in Indonesia. Management now expects a further dismal performance due to the impacts of COVID-19. In fact, the second quarter is likely to bear the largest quarterly impact of coronavirus this year. In the second quarter, currency-neutral revenues are expected to fall 8-12% due to the coronavirus-led hurdles, including reduced IQOS sales. Further, management expects earnings in the second quarter between $1 and $1.10 per share, including currency headwinds of about 12 cents. Earnings are expected to bear the brunt of distributor and trade inventory movements, lower duty-free sales and delay in minimum price enforcement in Indonesia.

Apart from this, receding cigarette sales volumes have been taking a toll on Philip Morris’ performance for quite some time now. In the first quarter of 2020, total cigarette and heated tobacco unit shipment volumes dropped 1.2% to 173.7 billion units. Cigarette shipment volumes fell 4% to roughly 157 billion units in the quarter. We note that cigarette shipment volumes are being adversely impacted by lower demand for cigarettes, stemming from anti-tobacco campaigns and consumers’ rising health consciousness. Moreover, regulatory hurdles have created limitations for marketing cigarettes, further hindering sales volumes.

Focus on RRP’s & Solid Pricing

To evolve with the changing consumer habits, Phillip Morris is making solid efforts to grow its footing in the RRPs space. Notably, the company had about 8% of shipment volumes and one-fifth of net revenues coming from smoke-free products as of the end of 2019. Toward this end, the company’s IQOS, a smokeless cigarette, counts amongst one of the leading RRPs in the industry. Notably, IQOS was launched in the United States in 2019, through a commercial deal with Altria (MO - Free Report) that was approved by the FDA. We note that RRPs formed around 22% of the company’s total revenues in the first quarter of 2020, including about 10% contribution from IQOS devices.

Strong growth in IQOS boosted revenues in the RRPs unit, which increased 25.1% to $1,555 million in the first quarter. Moreover, heated tobacco unit shipment volumes of nearly 16.7 billion units surged 45.5% year over year. The company expects consistent growth in IQOS and Heated Tobacco categories, and therefore has been committed to expanding these products.

Apart from this, Phillip Morris’s strong pricing has helped it stay afloat in the industry even in the face of declining cigarette volumes. Though higher pricing might lead to a possible decline in cigarette consumption, it is seen that smokers tend to absorb price increases owing to the addictive quality of cigarettes. Evidently, higher pricing variance was an upside to the company’s performance across all regions during the first quarter of 2020. In the said quarter, favorable pricing variance boosted the top line that improved 10% on a like-for-like basis, after excluding currency. Pricing also drove the company’s adjusted operating income.

Continuation of such trends is likely to aid Phillip Morris amid the aforementioned hurdles. Shares of the company have declined 5.1% in the past three months against the industry’s growth of 2.8%.

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