Philip Morris International Inc. (PM) Earnings Call Transcript & Summary

Good afternoon, everyone. We're coming to the end of our Staples conference. I'm Gaurav Jain, Barclays' Global Tobacco Analyst. I'm thrilled to have Emmanuel Babeau, the CFO of Philip Morris, here with us. Thank you for giving us the opportunity, Emmanuel. As you might have seen, Philip Morris raised the midpoint of its FY '20 EPS guidance earlier today, so we will have a few comments from Emmanuel before I get into my questions.

Gaurav, thank you so much for hosting us, and good afternoon, good morning, everybody. Very pleased to be with you to share the latest update on Philip Morris International. So I'm going to find a few elements on what we've been seeing over the summer and the month of July and August. And of course, the first element I want to comment is the fact that we have been revising and narrowing upward our EPS guidance range. We are now targeting a bracket between $5 and $5.07 per share for the adjusted EPS for the year. Remember, the guidance was previously with a range of $4.92 to $5.07. This range would represent a growth of approximately 3.5% to 5% versus 2019 at the same scope and same ForEx basis on an organic basis. And if we look at the reason for driving this improvement, it's basically because we are now expecting a Q3 that is going to be better than what we thought when we communicated the last time at the end of July. Indeed, we are now expecting for Q3 a reported diluted earnings per share to be broadly in line, excluding currency, with $1.43, which was the adjusted EPS for the third quarter of 2019. As we expect a negative impact of the currency of about $0.07 that would mean an adjusted EPS broadly in line with $1.36 for this third quarter. The reason for this revision upward of our expectation for Q3, is the fact that in July and August, we've seen the confirmation of the positive trend observed already in June of a gradual improvement of the trends after the difficult months of April and May. And we even have seen some market performing better than what we thought only a few weeks ago, that certainly has been the case in a few Western European market, but that also has been the case in other markets, such as the Philippines or Turkey. We also see a positive evolution of the outlook for pricing in Japan. I will be, of course, happy to elaborate on that in our discussion maybe later on. And that's going to help our performance in Q3 but also in Q4. We also expect some timing benefit, which are going to be inventory related in Q3, but this will be reversed in Q4. So that's going to be temporary. It's quite obvious that this improvement are being achieved in an environment that remains full of uncertainty, and we see day after day, I would say, the evolution of the news on the pandemic. I would say one thing is sure about the difficulty that we're going to face is that 2 markets are going to be difficult until the end of the year. The first one is Indonesia, where we see the country still facing difficulties. And I think a new type of lockdown was announced in Jakarta only yesterday. So the market is still facing some tough situation linked to the COVID. That is going probably to delay even further the implementation of a minimum retail selling price, and that's probably going to mean a tough situation in Indonesia until the end of the year. The other market that is going to remain a difficult is duty free. There was some hope for a beginning of a recovery towards Q4. I think with the pandemic rebounding in a number of countries, we see limitation to the travel emerging again, and that certainly will mean that duty free is going to stay very depressed until the end of the year. We have been continuing our nice growth in our reduced-risk product in July and August. We see continuation of the improvement on the acquisition pace for new IQOS user. I can report that for the July-August period we've been in 2020, we've been acquiring more new IQOS users than in the same period for 2019. And even now when we look on a year-to-date basis, at the end of August, we have been acquiring more new IQOS user at the end of August 2020 than what we have been delivering for the first 8 months in 2019. We also continue to innovate. You have seen that we have launched IQOS VEEV, vaping made right in New Zealand, where we are, of course, testing the product and also testing edge control, which is absolutely crucial for us, edge verification. And we have a very nice plan for rollout of IQOS VEEV in the coming months in other country towards Q4. We also have been launching a new reference for our heat-not-burn offering coming from our agreement with the KT&G. This is a lil brand and a lil SOLID reference has been launched in Russia, and not later than today in Ukraine. So we're going to have now a nice plan for rollout of this new offering on heat-not-burn product. And last element I wanted to share with you. We've also announced yesterday a dividend increase of 2.6% to move to an annualized rate of $4.80 per share. And quite obviously, in this challenging environment, this increase in the dividend is a sign of our confidence of the continuation of our successful journey in RRP in the future. I think with that, I have shared all the information that I wanted to share at that stage. And Gaurav, I'm really happy to answer your question now.

Thank you for those detailed comments. So I will run into the questions beginning with your guidance update. So you are highlighting better volumes in EU, which I would say was somewhat expected, but you are also highlighting better volumes in Turkey and Philippines. So do you think that this might be the beginning of a more broader turn up in emerging markets? And are you seeing a divergence happening in Asian emerging markets and LATAM emerging markets because those weren't highlighted?

Yes, Gaurav. So we have seen a number of an emerging market, or I prefer to call them new economies showing signs of improvement. It certainly doesn't mean that we are back to the normal and previous situation, but showing signs of improvement. I would say that the trend today is not really by region. I think it's largely driven on a country-by-country basis, depending on the economic situation and the measure that are going to be implemented. So Philippines is an example of a country that has been showing some improvement, Turkey as well. It is true that if you look at Latin America, for instance, Argentina is still a difficult market with a lot of impact linked to the pandemic. But at the same time, we cannot say that the whole Asia is improving as we see the difficulty on Indonesia. So I would really say it's more on a market-by-market approach that we can identify where are the places where we are seeing some nice improvements and where are the places where difficulty remain at a very high level.

Okay. Now another reason for your guidance upgrade is Japanese pricing. Japan is clearly a very key market for you. We think that it's almost a 14% EBIT exposure for you. The next 2 years will be very unusual in Japan because we will have 2 consecutive excise tax hikes. One will happen in October '20 and next in October '21. And we are seeing that both from [indiscernible] and Marlboro have raised prices by 10% this year. 2021 will also see the closure of the tax arbitrage in cigarillos, which has been impacting you negatively. So is it fair to say that between now and 2022, Japan would be a very major tailwind for you?

I mean we certainly expect to see Japan as a positive market for us in the future. Of course, there will be impact coming from this sequence price increase between October 2020 and October 2021. Linked with that, there is a number of evolution on price that are going to be favorable, and I alluded to the fact that it's going to help already our Q3 and Q4. But fundamentally, the reason why we expect Japan to be a very nice tailwind is because we are being very successful in this country with our IQOS offering. And therefore, because we are successful, we are gaining shares. That's a market that we have started to segment with 2 consumable offering with Marlboro, heat-not-burn stick and also its -- and this very nice differentiating the price positioning allow us to really cover very well the market. We will come with more innovation in the future in Japan for sure. So we are in good shape in Japan. We are progressing well. And you're right, it's an important market, and it's good to be in good shape in an important market for us. So definitely, we expect Japan to be a nice tailwind for us in the future.

Okay. Now coming to Indonesia. So it has been a difficult market throughout this year, and you have pushed out the quarters when the minimum retail selling price will be implemented consecutively. So how should we think about it now for this year and also maybe next year?

Yes. So Indonesia remains clearly a headwind for us. I think I've been commenting in great detail the various level of difficulties, all the price increase that we had taken in the past and the fact that we were already with a very significant price premium. The fact that there was a new increase in excise duty at the beginning of the year, which was extremely important that the minimum retail selling price not being enforced, meant that the gap was really important. Then I alluded to the fact that also the pandemic has been hitting us largely in large city like Jakarta, where we have over representation in terms of market share. And last but not least, the development of this Tier 2 system which is a kind of tax loophole, if you want, where some local players are developing and that is creating what is not the level playing field for all the players. I think the minimum retail selling price is eventually going to be implemented. So I said it, it's probably going to be only late in Q4. So difficult to see that really helping us this say, but hopefully it's going to be more positive from next year. We also mentioned that we were with our portfolio coming with a lot of commercial activity and proposal for the consumer to adapt to the evolution of the need. And then last but not least, we also expect the authorities to really take action to close this loophole, which is very damaging for the country because it is creating a gap in the excise duty that the country is collecting. We'll see what are the decisions towards the end of the year, but we are certainly hopeful that because it makes sense for the country, that will be the decision made in 2021. So we are expecting situation for this reason to increase in 2021, but it's too early to say exactly by which kind of magnitude because we need to see the answer on this various element that I've mentioned.

Sure. And could you just remind us if there is an excise hike planned in Indonesia because of this delay, that might also get pushed out in 2021?

Well, I'm not sure that there is a final position and decision today on what's going to happen in 2021. You're absolutely right. So it will need to be confirmed. I think like in many countries, the decision and the discussion will take place in the coming months. That's budget time now between now and year-end.

Sure. Now coming to IQOS. So you have a guidance of 90 million to 100 million sticks for FY '21. And then there is also this aspirational number of 250 billion sticks by 2025, which has been published in your sustainability report.

Absolutely.

As was mentioned by Philip Morris quite often. So how are you tracking versus your guidance and your aspiration?

We repeated when we communicate about our Q2. And of course, based on what I've just been sharing with you, can imagine that I'm going to do it again, we are on track to be next year between 90 billion and 100 billion of stick for heat-not-burn. And we are happy with the way we are progressing despite the COVID on IQOS and heat-not-burn. This is the guidance and we believe that we are well on track to deliver on that guidance. And this is, of course, one milestone. It's an important milestone, but it's one step in the continuation of what we expect to be a very strong growth in the future. The 250 billion is an aspiration, which is not just on heat-not-burn, but it's globally on the RRP offering that we are going to develop. And it's, I would say, mentioned or quoted in equivalent, if you want of stick, but that does include as well vaping, for instance. And of course, that means that we will need to be very efficient and successful in developing heat-not-burn, all other RRPs in the next 5 years. But I think I've been alluding to the launch of IQOS VEEV in New Zealand. You will see a lot of innovation coming in the coming quarters for PMI. I think we have the momentum. We have the understanding of the market. And we have the plan to go in the direction of this aspiration. And of course, we'll keep you posted on how we are heading towards this aspiration.

Okay. Now IQOS did receive an MRTP a couple of months back, which coincided with you joining the company. So I would like to -- I think there was some good luck there. Now we have also seen California has just banned flavored tobacco without having any exemption for MRTP products. So what exactly does this change on the ground?

I'm going to repeat again that really this MRTP authorization is an absolute landmark. So it's not the kind of final point, and there won't be no more, I would say, exchange and discussion with government authorities and states and with regulatory bodies. But I think it shows that it's time to move to something else. Let's stop the discussion. Yes, heat-not-burn. IQOS is a different product. It's a better product. And let's no longer put a motion, but rather speak about the topic based on scientific evidence and on science based fact. And as it is clearly a differentiated and better product, the real question now should be how do we make sure that for the current smoker, you make this product available, understood and you encourage the switch to this better product. It's going to take time. I mean we are not naive. We know that everything is not going to change overnight. And the decision in California is something that has been, of course, consider certainly before this MRTP was published. There will be certainly necessary explanation and war between the FDA and the various states. I think the FDA has a pretty good understanding of what should be done to avoid unintended use and what this new offering can do in terms of flavor. And they've been really clearly taking position on that. Let's do that by taking the time for discussion and gradually, things will happen. We are not starting from a blank page. As you know, Gaurav, 5 states have already said that they would implement a lower taxation of heat-not-burn versus conventional combustible cigarette. So it's not as if nothing was happening. Things are happening, but of course, more work and more discussion are needed, but we're going to go in the right direction.

Okay. Now just sticking to the U.S. market here. So Altria has communicated its plans to expand IQOS from 3 markets today to 7 markets over 18 months, which isn't really ambitious in our view. What is preventing the partnership from accelerating IQOS growth in the U.S.? And do you think you need to control the partnership?

Yes. Again, I think, that we need to organize the ramp-up in line with the sequence of events. So MRTP was a very important moment for us. And certainly for Altria as well, no doubt. We are, as you know, still waiting for a PMTA for IQOS 3. And it will be important to have IQOS 3 available for the consumer in the U.S. We're going to keep working with Altria on the rollout of the plan. But we need to do that gradually, and as we put the plan together. We have no doubt on the fact that Altria shared with us the great potential of IQOS in the U.S. We have a very clear agreement in place, which is governing our relationship in our partnership agreement, which is based on the licensing. They are in charge of marketing and commercialization. We will help them, but we need to build things in order and as the events are happening. So that's an ongoing thing, and we're going to keep working with them.