Philip Morris International Inc. (NYSE:PM) Q2 2023 Earnings Call Transcript

Philip Morris International Inc. (NYSE:PM) Q2 2023 Earnings Call Transcript July 20, 2023

Philip Morris International Inc. beats earnings expectations. Reported EPS is $1.6, expectations were $1.47.

Operator: Good day, everyone, and welcome to the Philip Morris International Second Quarter 2023 Earnings Conference Call. Today’s call is scheduled to last about one hour, including remarks by Philip Morris International management and a question-and-answer session. [Operator Instructions] I will now turn the call over to Mr. James Bushnell, Vice President of Investor Relations and Financial Communications. Please go ahead, sir.

James Bushnell: Welcome. Thank you for joining us. Earlier today, we issued a press release containing detailed information on our 2023 second-quarter results. The press release is available on our website at www.pmi.com. A glossary of terms, including the definition for smoke-free products, as well as adjustments, other calculations, and reconciliations to the most directly comparable US GAAP measures for non-GAAP financial measures cited in this presentation, and additional net revenue data, are available in Exhibit 99.2 to the company’s Form 8-K dated July 20, 2023, and on our Investor Relations website. Growth rates presented on an organic basis reflect currency-neutral adjusted results, excluding acquisitions and disposals.

As such, figures and comparisons presented on an organic basis exclude Swedish Match up until November 11, 2023. 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 is now my pleasure to introduce Emmanuel Babeau, our Chief Financial Officer. Over to you, Emmanuel.

Emmanuel Babeau: Thank you, James, and welcome everyone. Our business delivered outstanding performance in the second quarter of 2023, exceeding our expectations to reach a record high quarterly adjusted diluted EPS of $1.60. This was driven by impressive ZYN and IQOS growth, coupled with strong combustible results. We delivered total cigarette and HTU shipment volume growth of 3.3%, putting us well on track for our third consecutive year of positive volumes. This excellent result underpinned double-digit organic topline growth and high-teens currency-neutral adjusted diluted EPS growth. We also expanded our leadership in smoke-free products in the period. Firstly, IQOS’ strong momentum continued, with adjusted in-market sales volumes, led by plus 16%, and shipments up by plus 27%.

This reflects very good user growth of plus 1.4 million in the quarter and continued strong traction across the world. This is increasingly driven by IQOS ILUMA, which is now available in 23 markets, representing around two thirds of our IQOS business by volume. Secondly, and now two full quarters after the Swedish Match acquisition, ZYN is delivering an exceptional acceleration to our smoke-free business. US volumes grew by over plus 50%, including a notable step-up in June. We are delighted with this performance. Our combustible business also delivered better-than-expected results with over plus 7% organic net revenue growth after a very robust quarter for pricing and resilient volumes. This was a key contributor to the strong plus 7% organic operating income growth, with a plus 210 basis points sequential improvement in our adjusted operating income margin.

Turning to the headline numbers, positive volumes supported very strong organic topline growth of plus 10.5%, with continued excellent IQOS momentum and a further acceleration in combustible pricing. This does not include the remarkable plus 19% pro forma ex-currency topline growth of Swedish Match, led by ZYN, with combined pro forma ex-currency net revenues increasing by plus 11.1%. Our total reported currency-neutral net revenues grew by plus 19%. Our organic net revenue per unit grew by plus 7.0%, driven by the increasing proportion of IQOS HTUs in our sales mix and combustible pricing. Due to these positive factors, adjusted operating income grew by a very robust plus 7% organically despite continued inflationary headwinds. This excludes the tremendous growth of ZYN, and starting in Q4, our organic results will include Swedish Match.

Adjusted OI margins improved 210 basis points sequentially, and while still organically lower year-on-year by 140 basis points, this better-than-expected performance was notably supported by combustible strength and favorable timing of certain costs. We also increased our participation in the below Tier 1 segment in Indonesia, which now represents close to 40% of its industry volumes, and is slightly dilutive to our margins. This organic delivery, including the favorable timing of costs, combined with exceptional June ZYN volumes, and a lower tax rate, allowed us to outperform our most recent Q2 forecast. We delivered adjusted diluted EPS of $1.60, representing 16.9% growth, excluding an unfavorable currency impact of $0.13, notably due to the Japanese yen.

While the first quarter of the year contained some exceptional headwinds and distortions due to timing and comparison effects, our business delivered a strong first half, including volume growth of 1.1%. Organic net revenues grew by 6.8%, with Swedish Match’s excellent ex-currency pro forma net revenue growth of 17% for H1, demonstrating its growth accretion to our business. Combined pro forma currency-neutral net revenues increased by around 7.5%. Following peak margin headwinds and a notable operating income decline in the first quarter, the strong improvement in Q2 narrowed the H1 organic decline to minus 2%. As in Q2, this excludes Swedish Match, which delivered an excellent profit performance and made a significant contribution to our adjusted OI margins.

We expect continued strong reported and organic operating income growth in the second half. Despite these headwinds, we delivered 5.9% growth in currency-neutral adjusted diluted EPS to $2.98 in H1, providing a strong platform for the second half of 2023 and beyond. Let me now walk through the mechanics of our Q2 net revenues. While not included in our reported shipment volume growth of 3.3%, Swedish Match’s smoke-free volumes grew by 15%, providing impressive accretion to our overall growth profile. Combustible and HTU pricing contributed plus 6 points of growth. This primarily reflects combustible strength, partly benefitting from timing effects. As in Q1, HTU pricing was impacted in Japan and Germany by the annualization of 2022 excise tax increases, and in the case of Japan, the transition to ILUMA.

These factors will have less impact in the second half as annualization recedes. We also continue to expect greater visibility on the likely outcome of the court ruling related to the German tax surcharge toward the end of the year. The increasing proportion of HTUs in our business again contributed positively, reflecting higher net revenue per unit, partially offset by unfavorable geographic mix. The positive mix impact of HTUs, overall volume growth, and pricing, are powerful drivers of our transformation and growth. Let’s now turn to gross margins. While the year-on-year trajectory remained negative, we saw improvement versus the first quarter, driven by strong growth fundamentals. Indeed, we achieved sequential improvement of 1.2 percentage points despite increased inflationary pressures, as topline growth accelerated and supply chain disruptions and ILUMA-related factors started to dissipate in the quarter.

In addition, cost phasing and the geographic mix of inventory movements, notably for HTUs in Europe, increasingly normalized after an adversely affected Q1. Our IQOS business contributed positively to our gross margin in Q2, and we expect this to continue, partly mitigating combustibles. We expect further improvement in our year-on-year gross margin trajectory in H2 as headwinds continue to subside, ZYN’s outstanding growth continues, and the underlying drivers of our transformation accelerate. As expected, SG&A growth was much closer to net revenue growth in Q2, and at a more normalized growth rate with regard to our full year expectations. Indeed, with such a strong topline in Q2, SG&A costs were lower as a percentage of net revenues. While we continue to invest in IQOS and ZYN, our successful cost efficiency programs continue to deliver, helping to finance growth investments and mitigate inflation, which remains a headwind.

With $1.9 billion of gross savings realized to date, including $820 million from SG&A, we are on track to achieve our 2021-23 $2 billion target ahead of plan. Turning now to the 2023 outlook, we are raising our currency-neutral top and bottom-line growth forecasts. We aim to be a growth company starting with volumes. In 2023, we expect to grow total volumes for the third year in a row, even before factoring in the excellent progress of Swedish Match’s portfolio. As part of this growth, we are reiterating our targeted HTU shipment range of $125 billion to $132 billion, while we expect a cigarette volume decline of 1.5% to 2.5%. We are increasing our organic net revenue growth forecast to 7.5% to 8.5%, reflecting the continued momentum of IQOS, the resilience of our combustible business, and the ongoing excellent growth of ZYN, which we expect to contribute positively in Q4.

We expect strong organic operating income growth in the remainder of the year to support H2 margin expansion despite the headwinds previously mentioned and certain technical impacts. These relate to the increased use of third-party manufacturing in a few markets, such as Indonesia and Ukraine, and the related growth of the below Tier 1 segment in Indonesia I already mentioned. The full year estimated impact of these factors is around 40 basis points on our adjusted OI margin, and without this impact, we would expect to be broadly in the middle of our forecast organic margin range. On top of this organic evolution, we expect Swedish Match to add around 50 basis points of accretion. Our strong topline and OI outlook allows us to raise our forecast for currency-neutral adjusted diluted EPS growth to 8% to 9.5%.

This translates to a revised range of $6.13 to $6.22, including $0.33 from unfavorable currency at prevailing exchange rates, notably due to the Japanese yen and Russian ruble. This forecast continues to assume around $150 million for incremental investments in the US, and our Wellness and Healthcare business. It also assumes around $1.2 billion in net finance costs, which includes higher interest on variable debt, partly offset by better returns on cash deposits. As previously mentioned, our forecasts do not assume any contribution from a potential favorable ruling on the Germany tax surcharge. Focusing on the second half in more detail, we expect strong performance on all key metrics as smoke-free products deliver an increasingly positive impact.

In Q3, we forecast high single-digit organic topline growth, with HTU shipments of 31 billion to 33 billion units, and adjusted diluted EPS of $1.60 to $1.65, including $0.06 of unfavorable currency at prevailing exchange rates. Looking ahead to Q4, we expect notably strong reported and organic OI growth as certain inflationary impacts are annualized, and we increasingly benefit from an optimized ILUMA supply chain and consumables. As I mentioned, Swedish Match will also be included in our organic figures during the quarter. The exceptional growth of ZYN is clearly margin-accretive, as visible in our adjusted H1 figures. Turning back to our results, our total shipment volumes increased by 3.3% for Q2, and 1.1% year-to-date. HTU shipment volumes grew by 26.6% in Q2 to reach 31.4 billion units, notably driven by continued strong performance in Europe and Japan.

In addition to fundamental strength, HTU shipments to Japan were boosted in Q2 by around 2 billion units as we increased sea freight, with corresponding increases in inventory levels. As I mentioned earlier, total PMI adjusted in-market sales volumes of HTUs increased by 16% in Q2, continuing the excellent trend seen in Q1. H1 shipment volumes grew by 18.5%. Notably, this does not include the excellent growth prospects of oral nicotine, for which shipment volumes grew by 14% in Q2 and 12% in H1 on a pro forma basis. Cigarette volumes declined by a modest 0.4% in Q2, with notable support from Turkey and Egypt, and by 1.7% for H1, reflecting a solid category share performance in a resilient category, despite stepped-up pricing. Our smoke-free transformation continues to progress rapidly.

Due to the continued impressive performance of IQOS, heated tobacco units comprised 16.4% of our total shipment volume in H1 as compared to 14% in the first half of 2022, despite a resilient cigarette category. Including oral smoke-free products, this would be close to 18%. Powered by IQOS and ZYN, smoke-free products made up 35% of our adjusted net revenues in H1, compared to 30.9% for the same period in 2022. IQOS devices accounted for approximately 4.5% of our H1 inhalable smoke-free net revenues. Focusing now on combustibles, our portfolio delivered strong organic net revenue growth of 7.4% in Q2 and 5.2% in H1. This reflects strong Q2 pricing, with a notable contribution from Indonesia and the Philippines. While we don’t expect the exceptionally strong Q2 pricing of 9.4%, which benefitted from timing factors, to be fully replicated in H2, we now forecast a full-year increase of 7% to 8%.

Our cigarette category share grew by 0.7 points in Q2 on a year-over-year basis, including contributions from Duty Free, Egypt, and Turkey, and by 0.1 point in H1, resulting in only modest volume declines. Our leadership in combustibles helps to maximize switching to smoke-free products, and we have fully achieved our ongoing objective of stable category share over the last 18 months, despite the impact of IQOS cannibalization. The combination of our stable share in combustibles and the continued growth of our leading smoke-free brands, positions us to deliver total market share growth over time. We captured 1.1 points of international cigarette and HTU share in Q2, and 0.5 points in H1, with notable contributions from Turkey and Japan. Impressively, despite increasing competition in many markets, our volume share of the growing heat-not-burn category remains stable at around 75%.

This is supported by ongoing ILUMA market launches and increasing focus on our two-tier HTU portfolio, providing adult smokers with an expanding range of innovative and high-quality alternatives to cigarettes. PMI HTUs again strengthened their position as the second largest nicotine brand in markets where IQOS is present, with a sequential share gain in Q2 of 0.2 points to a record 9.2% share. We estimate there were 27.2 million IQOS users as of June 30th. This reflects excellent growth of 1.4 million adult users in Q2, with notable progress in Japan and Europe, in addition to a broad range of other geographies. While fundamentals remain very strong, I remind you that Q3 user growth can often be below the average for the year due to the seasonal factors evident in prior years.

I will now turn to IQOS in the Europe Region, where we are approaching a milestone of 12 million users. This reflects the further roll-out of ILUMA, which is now available to around 70% of IQOS users in the region, and the expansion of our two-tier portfolio. As an illustration of its progress, TEREA is already close to 100% of our HTU in-market sales volumes in the first launch markets of Spain and Switzerland. Our second quarter HTU share increased by 1.6 points year-over-year to 9.0% of total cigarette and HTU industry volume. While sequential share is, as usual, optically affected by the seasonality of the cigarette category, adjusted in-market sales volumes continue to exhibit robust sequential growth, and reached a record high on a four-quarter moving average.

This reflects strong year-on-year growth of 20% in Q2, outstripping the 11% growth in HTU shipments, which were affected by some residual effects from the inventory dynamics seen in Q1. We expect robust growth in HTU shipments, adjusted in-market sales, and overall region organic net revenues in the second half. We continue to be encouraged by the increasing number of European countries adopting multi-year excise tax plans, with clear differentiation of smoke-free products. Over half of EU member states have now passed multi-year plans. Also in the EU, a number of member states are currently transposing the Delegated Directive, withdrawing the heated tobacco product exemption from the flavor ban into national legislations. The ban is scheduled to come into effect on October 23rd, and we will be adjusting our HTU portfolio as required, in line with this transposition.

While short-term volatility is possible, we do not expect a significant change in the structural growth of the category. To give some further color on our continued progress in the region, this slide shows a selection of the latest key city offtake shares. The success of IQOS continues across a diverse range of geographies from Western, Southern, Central, and Eastern Europe, including markets with and without ILUMA. Despite the denominator effects of the combustible category I just mentioned, share results remain very strong. We are very pleased with trends in Rome, showing a sequential step-up to 28% share following the ILUMA launch. Robust progress in London and Munich also bodes well for these two key markets. While the Q2 2022 comparison for share in Vilnius was helped by the popularity of certain bundle offers, the share of over 40% remains impressive, and underlying offtake continues to grow.

In Japan, IQOS ILUMA continues to drive impressive growth momentum. Smoke-free products made up over 75% of our Japan net revenues in H1, clearly showing the path for the broader company. Adjusted total tobacco share for our HTU brands increased by 3.4 points in Q2 to 26.3%, further strengthening TEREA and SENTIA’s positions as the clear number one and two heat-not-burn brands, despite intensified price competition for mid and low-price offerings. Importantly, adjusted in-market sales volumes again grew sequentially, reaching a record high of 9.3 billion units on a four-quarter moving average, as IQOS outgrew the heat-not-burn category. In addition to this excellent consumer trend, our Q2 shipments to Japan also benefitted from progressively switching back to sea freight during the quarter.

In addition to strong IQOS gains in developed countries, we continue to see very promising growth in low and middle-income markets. This slide highlights a selection of Q2 key city offtake shares across markets in Eastern Europe, Africa, Asia, and Latin America. Notable ongoing successes include Egypt, with Cairo offtake share surpassing 8.5%, and Bulgaria, with offtake share in Sofia exceeding 15%, despite the usual impact of seasonality that I mentioned. We continue to see robust offtake volume growth across these important future markets. Now moving to Swedish Match, which is meaningfully accelerating our smoke-free growth trajectory. As covered earlier, the business delivered outstanding currency-neutral net revenue growth of 19% in Q2 and 17% in H1.

This means that in the first half of the year, Swedish Match has added 70 basis points of currency-neutral growth to our pro forma topline, and 60 basis points to our adjusted OI margin. In the US, ZYN delivered another exceptional quarter, with volume growth of over 50%, reflecting positive momentum across the country. Elsewhere in smoke-free, recent trends of share gains in US moist snuff, as well as category mix headwinds in Scandinavia, broadly continued. The cigar business performed well, with Q2 organic net revenue growth of 16%. This reflects ongoing share gains despite being an early mover on category pricing. I would like to again congratulate and thank all the Swedish Match employees for continuing to deliver terrific results as we thoughtfully integrate our activities, which is progressing very well.

Looking at ZYN’s US performance in more detail, exceptional year-over-year volume growth in cans of 53%, also reflects a 22% sequential increase versus Q1, 2023. This accelerated growth reflects progressive increases in distribution and a broad nationwide step-up in store velocities as the category gains strong traction with adult nicotine users for its convenience and pleasurable experience. This includes California, which implemented a statewide flavor ban in December. While such elevated rates of growth may not continue indefinitely, the structural indicators remain very encouraging. Impressively, ZYN category volume share grew 2.2 points compared to prior year and 1 point sequentially, despite continued discounting from less premium offerings.

Retail value share also grew to 76.8%, highlighting its premium positioning and superior brand equity. Now, let me provide an update on our innovation and expansion plans as we further accelerate our smoke-free transformation. First and foremost, the global roll-out of IQOS ILUMA continues to be a top priority. We launched ILUMA in six markets in Q2, and with HTU manufacturing constraints now normalized, we aim to be present in around 50 markets by the end of the year. The most significant opportunity to drive accelerated growth is in the US We are investing behind ZYN and readying our organizational and commercial capabilities for the launch of IQOS in Q2 next year. As mentioned in today’s release, we are also on track for IQOS ILUMA PMTA and supplemental MRTPA submissions in Q4 2023.

Our philosophy on the US remains unchanged. We will seek to accelerate our topline with IQOS and ZYN, supported by disciplined investment and leveraging both our extensive experience in smoke-free products and Swedish Match’s infrastructure and knowledge, while continuing to deliver strong bottom-line growth for PMI. Our pilot city launches for BONDS in the Philippines and Colombia continue to progress well. The learnings from these markets will be integrated as we roll out more broadly, starting next year. The international expansion of nicotine pouches remains a key medium-term opportunity, notably for ZYN as the world’s leading brand. We are now preparing for the launch of – re-launch of ZYN in several markets. In e-vapor, our refocused approach in select markets is progressing with VEEV ONE, our newly designed pod-based system introduced in four markets, and VEEV NOW, our disposable product, in six markets.

Now let me discuss our Wellness and Healthcare segment, starting with its first clinical trial results for our inhalable aspirin product. While it was observed that the experimental product had a rapid onset of effect, which is the key medical advantage sought, there was significant variability in inhaled dose among subjects. The study was therefore deemed unsuccessful, and as a result, product design improvements are required. Our plan was to file this product with the FDA later this year. However, additional time is now required, and the outcome is therefore less certain. In addition, the CDMO business has been facing slower-than-anticipated development, including cost-related challenges. Consequently, we recorded a non-cash goodwill impairment from our annual assessment, as detailed in today’s release.

While these elements will postpone the achievement of our 2025 aspiration to reach over $1 billion of net revenues from Wellness and Healthcare products, they will result in a corresponding decrease in the level of investment in 2024. Our ambitions to build and monetize our product pipeline are unchanged. As in the early days of developing IQOS, certain headwinds are to be expected, and the 2021 acquisitions in this segment have provided us with unique and enabling R&D capabilities. We remain committed to developing our Wellness & Healthcare business and continue to see attractive mid and long-term growth potential on many fronts such as inhalable drugs, NRT, and consumer wellness products, including non-recreational cannabinoids, in line with applicable regulatory requirements.

We also aim to accelerate Vectura’s growth, and will be exploring potential partnerships to enhance its CDMO business. We plan to discuss all these topics, including our plans for IQOS in the US and a full update on our Wellness & Healthcare business at our Investor Day on the 28th of September in Lausanne, Switzerland. Moving now to sustainability. Addressing the product health impact of combustible products by switching adult smokers to smoke-free products, such as IQOS and ZYN, remains our most critical priority. This transformation is at the core of our strategy, driving accelerated growth and returns over time from a more sustainable business. In addition, we remain committed to delivering best-in-class progress in other key sustainability areas.

With our extensive agricultural and manufacturing supply chain, human rights are a very important responsibility for our company. We released our first dedicated report on the topic last month, detailing our strategy to promote, respect, and protect human rights, and the progress to date in implementing our human rights commitment. Our performance on human rights is included in the 19 KPIs of our Sustainability Index, which comprises 30% of executive long-term equity compensation, weighted towards our product transformation. Our goal is to conduct comprehensive human rights impact assessments in our 10 highest risk markets by the end of 2025. These help us better understand and address our impacts, and we are making excellent progress, with seven completed to date.

Addressing climate change is another priority for us, and I’m pleased to share that PMI was included in Forbes’ first ever Net Zero Leaders List, ranking seventh overall for all US public companies, higher than any other consumer products or services company. To conclude today’s presentation, we delivered a very strong first-half despite a number of headwinds, putting us on track for the third consecutive year of positive volumes and organic net revenue growth of over 7%. The powerful trajectory of our smoke-free business gives us confidence in a strong full year performance, with excellent operating income growth. Outstanding momentum continues for IQOS and ZYN, the world-leading heat-not-burn and oral nicotine brands, and we have exciting plans to further grow oral nicotine pouches in the US and internationally, along with the US commercialization of IQOS next year.

Importantly, we remain steadfast in our commitment to generously reward our shareholders, including through our progressive dividend policy. In short, our smoke-free transformation continues to deliver sustainable growth. We look forward to sharing more with you on the next phase of our transformation at our Investor Day on September 28. Thank you very much, and we are now delighted to answer your questions.

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Q&A Session

Operator: [Operator Instructions] Our first question comes from Pamela Kaufman from Morgan Stanley. Your line is now open.

Pamela Kaufman: Hi. Good morning. I wanted to ask about your full year guidance. You exceeded your own Q2 guidance by at least $0.13, but did not flow through the EPS to the full-year outlook, even when factoring the greater FX headwind. What’s tempering the flow-through of Q2 upside, and how much does this reflect conservatism around the balance of the year versus a more cautious outlook on the second half or higher investments? Thanks.

Emmanuel Babeau: Thank you, Pam. When we look at the driver for beating our initial expectation for Q2, I think we can probably make three buckets. One is the outperformance of ZYN versus our expectation, and that’s something that we are of course taking into account as we see a better trajectory for ZYN than initially anticipated. Remember that will only contribute to our organic growth on revenue in Q4. But that is of course helping the adjusted EPS growth excluding forex. We also see some cost that has been moved to H2 and that is if you want cause that are we going to see in H2, so it’s not a net addition for the year. And then there was, as we said, some better news on a financial cost of course from our debt. There was also some element on tax and of course this one is more uncertain and more difficult to predict for the second part of the year.

But I think as always, we are building scenario for the full year. We’ve been including in a clear way what we see a real change in the trajectory and on which we have visibility for the second half on things where we have postponement of things with good news, but of course we still a lot of uncertainty on H2. Of course, we have to be a bit more cautious when we take them in the scenarios.

Pamela Kaufman: Okay, thanks. And then just on operating margins, you pointed to operating margins closer to the lower end of your initial guidance range of down 50 to 150 basis points for the year. Can you discuss the puts and takes impacting your margin performance in the second half?

Emmanuel Babeau: Sure. When you look at the margin, really things are happening as expected, I would say. So, after Q1, which was not coming as a surprise to us, we said from now on, we’re going to see an improvement of the margin trajectory. We knew that inflation would still be there for the rest of the year, although in the second part of the year, we are going to be facing comparison where inflation was starting to kick in, so that’s going to have some impact. But we knew that a number of other headwinds would start to abate, and here I’m talking about the disruption on the supply chain and among other things, things connected with air freight, the cost attached to the launch of ILUMA, and the fact that not everything was optimal.

So, we started to see improvement in Q2 as expected, and we’re going to continue to see improvement in the rest of the year. And then what we see playing in Q2 that we expect to see playing in the rest of the year are the fundamental positive drivers that we have for our margin. First of all, the fact that IQOS growth is having a positive impact on our margin. We said it in the beginning, we expect a positive contribution on margin evolution for the year from the IQOS business. Remember, we have a higher gross margin rate on our consumable for IQOS. So, as we are growing IQOS, that is having a positive impact. There is no – when it comes to our smokefree business, another driver that is positive for our margin, which is ZYN, and ZYN in the US, which is also accretive to the margin.