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

Good morning, everyone. Thank you for joining our 30th Barclays Global Staples Conference. I hope summer provided you and your families enough opportunity to recharge and travel. I'm Gaurav Jain, Barclays' global tobacco and cannabis analyst. Joining us today for the first session of the day is Emmanuel Babeau, the Chief Financial Officer of Philip Morris International. Thank you, Emmanuel, for giving us the opportunity, again, to host you.

Thank you, Gaurav, for having me.

Thank you, Emmanuel. So Philip Morris is up 31% year-to-date, and it still is trading at 16x P/E for what is likely to be a low to mid-teens EPS growth company, and that is something that the company has just reaffirmed for this year. It is our topic in the sector. I will first turn it over to Emmanuel for his opening comments before asking him some questions that are on top of investors' minds. Emmanuel?

Thank you, Gaurav. Hi, everyone. Super pleased to be with you. Like Gaurav, I hope you all managed to have a good summer break and that you are all in great shape to restart. Before I start with a few preliminary comments, I just draw your attention on our forward-looking and cautionary statement that you're going to find on Page 2 and Page 3 of the document that we are sharing with you. So Gaurav, before we dialogue together, a few preliminary thoughts. Globally, the business has been very well oriented for us through the first months of our third quarter, and we are on track for a very strong performance, both for Q3 and for the full year. I'm going to give a bit of color behind this performance. First of all, we continue to have a very good performance on volume. We have seen a good continuation of the trend, and we target to be growing volume for the full year. I think that would be the first time in almost 10 years that, together with heat-not-burn and CC, we are growing volume. And of course, that is the strength of IQOS and IQOS is growing its shares and keep growing very, very strongly in the portfolio. That explain this growth for the year. We have seen a continuation of a strong momentum on IQOS in key geography absolutely through the first month of the quarter, very strong demand for the devices, very strong demand for the consumable. And we expect for the third quarter to have shipment between 23 billion and 24 billion stick and in-market sale between 24 billion and 25 billion stick. That's for the third quarter. Of course, the headline for us of the third quarter when it comes to IQOS has been the launch of ILUMA in Japan. Frankly, it's a tremendous success for the first weeks. We have seen a super sale in term of devices, great consumer offtake for the consumable. And certainly, what is maybe the most important element, we've seen that 12% of the ILUMA buyers are new user, new consumer for heat-not-burn. And that mean that we have a nice tool to convert more people to heat-not-burn with ILUMA. That was the objective, and the first number seems clearly to confirm that it's working very well. We also got some amazing comment coming from this ILUMA user, and they are really very, very positive on the overall ILUMA experience. We also have seen the combustible market behaving well and showing good resilience in many market through the summer. We continue to target an improvement in the sequential evolution of our market share, and what we've seen during the summer is absolutely confirming this ambition. So based on this good summer, we are now targeting to be in the upper end of the guidance that we had shared at the end of Q2 for our adjusted EPS, which was this $5.97, $6.07 adjusted EPS range. And we are targeting, and we confirm that for the Q3 adjusted EPS, we are targeting to be in the range of $1.50 to $1.55. So I told you, we see the continuation of a very strong demand for IQOS. We haven't seen an improvement on the situation of shortages on semiconductors. If anything, here and there, we've seen a bit more tension and, therefore, no real improvement. And that is creating a situation in some market, not everywhere, in some market of tighter availability on devices. So in this market that are being impacted, we see some situation of sometimes shortages; reduction in assortment, as we said at the end of Q2; narrower range being available in term of type of device, in term of color, I mean, what is making the choice; and ultimately, convincing new user to join. So we expect this situation, if it was to continue toward the end of the year, to have some impact in our user acquisition rate in H2. In addition to that, and of course, in line with what I've just been saying, we decided after Japan to postpone the other launches that we were planning for IQOS ILUMA in H2 of 2021. And the reason for that is very simple. When we launch ILUMA, of course, we have this conversion I was referring to of new user in Japan. But the majority of the ILUMA user are already existing IQOS consumer. So launching ILUMA is not optimizing our potential for new user acquisition. And we think that is the right thing to do, to postpone by a few months the launch to the first half of 2022. And that also is going to have an impact because, obviously, we were planning to build inventory to a company with a new consumable area, the launch, and this is not going to happen. One market is going to be particularly impacted by what I've just been describing. That is Russia. First of all, because in Russia, one of the main reference is IQOS 2.4+, and this is a reference that is most impacted by the shortage of semiconductors. And second, because we were planning to launch in Russia, ILUMA in the second part of 2021. And here, like elsewhere, it's going to be postponed to the first half of 2022. Just to be complete on Russia, we continue, as we said at the end of Q2, to see strong competition globally coming from the other player in the RRP category with a lot of aggressiveness in discounting devices. And as you can imagine, we are not answering to that given the situation of shortage that we are facing. And we also continue to see a CC business that is quite resilient on the Russian market. So if I take everything I've been describing on this situation of shortages and impact, we believe that we could have a negative impact, once again, if things continue to be difficult until the end of the year. That could be between 2 billion to 3 billion stick. That include 0.3 billion coming from Belarus. Because of the sanction, we have to stop selling IQOS there. Nevertheless, we absolutely confirm that we are going to target to finish between 95 billion and 100 billion stick. But if the difficulty were to continue toward the end of the year, we could rather be in the low end of this 95 billion to 100 billion stick. That is our target for the year. Now just 2 other element to complete my introduction to our discussion. First of all, as you have seen, but I'm sure, Gaurav, you will want to come back on that. We've been quite active in pushing our Beyond Nicotine strategy during the summer with the proposed acquisition of Vectura, with the announcement of the acquisition of OtiTopic. And that was, of course, following what we have been announcing on Fertin just before the summer. And last but not least, of course, we have announced what I think is a very important milestone in our journey to really put sustainability at the core of our transformation and at the core of our company, which is -- I believe it is the first of its kind. If it's not the first of its kind, it's really [ pioneering ] this business transformation, linked financing framework. And what does it mean? Well, it means that including in the way we are financing our company, we want to put this objective of bringing new and better products for the 1 billion smoker on the planet as an element to determine how we finance the companies to further push us, incentivize and make sure that we are going in the right direction in our ambition. That is also onboarding another category of stakeholders. I think it's important, the lenders, because the lenders now, with this framework, will also have a vested interest in pushing us to reach the right objective and will be with us to accompany us to reach our target and our ambition to unsmoke the world. With that, Gaurav, I'll finish my introductory comment, and I'm really happy to start the dialogue with you.

Sure. Thank you, Emmanuel. So on this 2 billion to 3 billion shortfall in IQOS volumes for this year, could you just help us understand like how much is because you're not building inventory for [ Teria ] this year? And how much is the Belarus sanction? And does it mean that your shipping will be less than the in-market sales, i.e., it could create a positive tailwind for FY '22 as and when these shortages ease?

Well, look, Gaurav, so what I said is that Belarus is going to be about 0.3 billion stick less because of the sanction. I'm not able to put a precise number on the impact coming from the postponement of the launch of ILUMA. But I would say it's going to be material in the 2 billion to 3 billion, but the biggest -- once again, if the amount was confirmed, the biggest impact would still be coming from a lower acquisition rate in a few market versus initial expectations. So that's in term of order of importance. I would put lower acquisition of user as the first one, then a lower level of inventory because we're not launching ILUMA and then the Belarus impact. I'm not able to comment at that stage on IMS and shipment. Maybe I will be able to be more precise when we are coming with our Q3 numbers.

Sure. And when I hear all the comments being made by auto companies or from the semiconductor companies like I think Intel is out today saying that they will put EUR 90 billion (sic) [ EUR 80 billion ] in Europe. So clearly, people are talking of multiyear shortages in semiconductors. So does this, therefore, reduce your expectations for FY '22 user acquisition and FY '22 IQOS volumes as well?

We're not changing our ambition, Gaurav. I think that -- let me correct. It's a very fluid situation. It's moving very fast. And things that we are hearing today could be different from what we've been hearing a few days before. We are, as you can imagine, incredibly active to ensure that we are rapidly back on track and back on normal. We are working with our partners. We are very active on the spot market. We are thinking on design of product to optimize and try to avoid where we see shortages. I don't believe that this is going to stay forever. We believe, for the time being, and that's our assumption that we're going to be back to normal in 2022. But I have to admit that I don't have the visibility. And once again, it's a fast-evolving situation. But we are not at all changing our ambition and the trajectory that we have designed based on what we see today.

Sure. Now just moving to a few other topics. So one is share repurchases, which recommenced this quarter after your Q2 results. Now your EPS guidance for the next few years is excluding share repurchases, and I think consensus is still, I think, is based using your guidance. So do you think you want to change your EPS growth guidance from greater than 9% to greater than 11% once we layer in share repurchases?

Look, Gaurav, so first of all, you're going to see that we have started on a soft note buyback largely because we had a lot of a blackout period because of the refinancing and the launch of this new transformation-based framework. But as we said, you should not expect a kind of linear buyback but more opportunistic, and that's exactly in line with the philosophy that we have highlighted. Having said that, you're absolutely right. This is going to have a positive impact that is going to come on top of the more than 9% adjusted EPS CAGR that we mentioned. I'll let you make your assumption on at what price we're going to buy on average and what's going to be the time line for that. But yes, you're absolutely right. It's going to be a nice addition to the ambition that we've been sharing a few months ago for the 3-year period, 2021 to 2023.

Now going to the Beyond Nicotine strategy. So your target is $1 billion in revenues by FY '25. And through Fertin and Vectura acquisitions, you are on track to add about $400 million in revenues. So what's your strategic rationale behind these deals and then to close the gap between $400 million to $1 billion? I mean I'm sure these companies will not organically grow to that number. So should we expect a few more deals and like inhalables and all the new terms you are teaching us these days?

So watch out, Gaurav. I don't think you can take the full numbers of Fertin as Beyond Nicotine because you have nicotine in their business. So when we can, we will clarify exactly what is the non-nicotine amount, but it's not probably as high as the one you have been describing. Now we said it. We believe very strongly that the $8 billion investment that we've made in innovation, in R&D, in being skilled in this inhalable space as we were building the IQOS business is giving us the credential, the capacity to build 2 new very nice businesses in 2 area. One is what we call self-care wellness. The other one is inhaled therapeutic. And of course, both with Vectura, with OtiTopic, we are pursuing the inhaled therapeutic way. And Fertin is a combination of modern oral, but it's still nicotine linked and, of course, also for self-care wellness. These 2 blocks are going to come -- or these 2 acquisitions, if we finalize them, are going to come as very nice platform, adding to what we have already. So we have already, in the pipe, a number of project or product that we want to launch that are along this line of self-care wellness and inhaled therapeutic. And of course, we're going to launch them in the coming years, and they're going in an organic manner if you want to add to that. We think that with the proposed acquisition or acquisition that we have made, we're going to accelerate that. And we think that we have now, with this acquisition, once again, once it will be finalized, if they are finalized, a very strong platform for these 2 businesses that we think we can develop. It will be largely organic from there. Does it mean that we cannot think of, as I said, a couple of other bolt-on to add some new capacity in area where maybe after this acquisition we would not be necessarily with everything? Maybe, but it's not certain. So that's the way you should be looking at things.

Okay. Sure. Now drilling down into a few of the markets, so going to Japan. So the cigarillo tax gap in Japan is going to close soon. So do you have more visibility now into how this impacts your Japanese business? Is this going to be a major tailwind going forward?

Well, that could be a positive, Gaurav, indeed. I think we have to remain a bit cautious and see how things unfold with the behavior of the consumer. But clearly, there is a possibility that some of the cigarillo user will move back or will move to the CC, the cigarette business. And that could generate for us given our presence there that is stronger than in cigarillo, not only with the Philip Morris brand, that could be a nice tailwind, as we say. But some of the cigarillo consumer could stay on cigarillo. It's likely that some low price offer will stay. And it's too early to say are they going to split themselves, if you want, between the very separate opportunity. But there is potentially, you're right, a nice plus for us to be confirmed.

Okay. Sure. And another question on Japan. I mean Japan is your most important market. I think it's about high teens of your EBIT. So Japan has had excise tax hikes on a regular basis for the last 2 years, and it has helped you price, and given the overall company, a nice pricing tailwind. And so far, there is no excise tax hike planned beyond October '23 -- beyond October '22, sorry. So does it become -- like pricing become difficult in Japan after that time? And how do you plan to manage that in your biggest market?

Well, Gaurav, first and foremost, no or lower excise duty is good news. Let's be clear. Excise duty is making availability of our product for the consumer more difficult, and it's generally not good news for the business. We know that it has an impact on volume and that has been demonstrated quite broadly. So I would say, first of all, probably overall positive for the industry. Now what does it mean in term of capacity to increase price? We'll see. I'm a believer that we're going to be in a slightly more inflationary environment in the coming years, at least in the foreseeable future and maybe even in Japan as well. That will mean that inflation will be a bit higher and price increase will be more acceptable or possible even in the absence of excise duty increase. So I would not necessarily take a negative view on price increase capacity. And certainly, I believe that lower excise duty is generally good news.

I hope could be. Now coming to Europe, which clearly is your -- overall, EU is your biggest market. So there heat-not-burn benefits a lot from lower excise taxes. I think it is about 1/3 of cigarette taxes.

Yes.

And we have the discussion around EUTPD III, which is currently underway. So do you see this tax gap closing? And we have seen Germany make a move. Tax next year there will be almost 80%, if not slightly higher. So how does that impact your business? And your thoughts on that would be really helpful.

Look, I mean, nobody knows the timing and what's going to be the outcome of the TD and TPD revision. So I'm not able to elaborate on that. I think we are certainly hopeful that based on scientific evidence, based on the fact that a few countries are clearly now recognizing tobacco harm reduction as an important tool for public health policy and follow that, we are hopeful that we're going to have a positive outcome for this 2 development, but, of course, it's too early to say, and we'll keep you posted on what is happening. On the tax differential, well, of course, we regret that Germany has been reducing to 20%, noting that this is a difference in Japan and that it did not prevent us from having a very nice growth in Japan and having a very successful business there. We think it's insufficient to mark the difference between heat-not-burn and CC and does not reflect a much better nature of heat-not-burn product versus combustible. We think that we should be certainly north of 50% in term of differential in order to both allow us to amortize all the investment that we have made in the past, the $8 billion. We need to have some amortization of this investment, and allow also to offer product that are going to be cheaper for the consumer to help conversion from cigarette to heat-not-burn product. Now why is I think super important and for me, that's probably the most important thing is that Germany is recognizing the better nature of heat-not-burn product, and it's in the law. It's recognized. And to see Germany recognizing that for me is a major milestone in making sure that key country, one after the other, we know that U.K. is quite advanced, they recognize that reduced risk products are a much better alternative than cigarette, and that should be taken into account. I note that globally, in Europe, all the vaping, the e-cigarette are far less tax than heat-not-burn. And they are -- they could be seen as having some similar impact in term of harm reduction. So I think the debate is still to happen. And actually, one could say, well, heat-not-burn should rather go towards the lower taxation of e-vaping in the future to reflect similar impact on public health. The debate is open, but we see a few positive evolution. And if you allow me one second to go beyond Europe. In the later development that we've seen in Pakistan and in Egypt, there are no clear legislation recognizing the objective of tobacco harm reduction and having tax differentiation that are in line with what we thought should be the rule, which is to be north of 50% difference between heat-not-burn excise and CC.

Great. Now coming to some of the other NGP. So e-cigarettes, you have launched in Czech, Finland, the IQOS VEEV product and also in New Zealand. When do you plan to launch them in the major EU markets like U.K., France, Germany? And what has been your traction so far?

Look, we started, of course, slowly on VEEV. We wanted to test the product. We wanted to come with something which was real improvement versus what was existing on the market, so it was not about you know us coming with a me-too. So great product, great design, great technology and great experience. We wanted to test key features like age verification that was really important for us when we were coming to e-vaping. And I think we built that in the first market as part of the IQOS team for the poly user between heat-not-burn and vaping. That was largely the start. We start to have from the market, the key market, a great feedback on the overall consumer experience. We have now people testing versus competition and VEEV compared extremely well versus other existing products. So it's going to be time to accelerate. We plan the launch in the coming months or before the end of the year in 7 to 8 markets. I think that will include France, by the way, and a couple of other important market. So time to accelerate, but we wanted to make sure that we were starting on a good note. And again, what is important for us is that the feedback from the consumer is very positive and confirm that we have a great product.

Sure. And just on the semiconductor shortages. So that is impacting IQOS, but that will not impact the e-cigarette devices?

Well, we don't see that for the time being as a major issue, but I want to remain cautious because, once again, we see situation moving fast. But for the time being, we have a plan for, as I said, about 7 market for the coming months, and we stick to it.

Sure. Now coming to the favorite topic, of Altria and Philip Morris merger, and there has been a renewed speculation around that.

Well, that's your favorite topic, Gaurav. That's not mine.

But what are your thoughts on having any sort of discussions around that anytime soon?

No. I mean allow me to lay the speculation aside. I think we've been very clear on that one. I can tell you that the priority for us on the U.S. today is to build a great RRP team. That starts, of course, with IQOS, and we want to make sure that we give the best possible support to Altria in developing IQOS in the market. But it, of course, means that we also want to develop other category like nicotine patches. And we mentioned already that we had some ambition for VEEV and for vaping in the U.S. So our objective today and what is really keeping us busy is to work on building a nice proposition globally for RRP product in the U.S. That's our priority today.

Sure. Now coming to the -- another question on the U.S. market and these lawsuits between BAT, Philip Morris, Altria. And we have the date 15th of September when the ITC full commission will rule. So what happens if they uphold the decision of Judge Cheney and you have to stop the importation of devices?

So I think that the date has been moved to the 29th, Gaurav, if I'm not mistaken. I can check that, but I think there was a postponement by a couple of weeks that has been announced. So let's remember the sequence. So you have an initial determination. Now the commission is looking at it, and they said that we'd be looking at a number of element on the patent and on other element like interest for public health. We have seen everywhere else in the world all the claim of BAT being repealed. We've been winning 11 in a row without a single defeat on all the claim of BAT in Europe. Their patent has been the 2 patent that are in question in the U.S. have been invalidated in the U.K. One of them has been invalidated by the European Patent Office. So it's a succession of win and confirmation that they don't have a valid patent and that we own everything we need to do our business and that there is no problem. So we are still hopeful that, ultimately, we will prevail with the ITC. Just to be complete on the time line, if -- which we hope it won't be the case, but if the decision from the commission was negative, you still have a 60-day presidential review potentially. That would be another milestone in presenting our case. And then we'll see. In the event that at the end of the day we are not prevailing, yes, of course, we are working on fallback option, as you can imagine. And we are working very diligently on it. But once again, we are hopeful that we're going to prevail.

Sure. And one last question before we close the discussion is on the work that you are doing on sustainability. And the target that you have set for yourself, that greater than 50% of your revenues will be smoke-free by 2025. Now it is very easy for critics to dismiss your effort, because even in -- even that in 2025, the majority of your sticks will be cigarettes and in your biggest market, which is Indonesia by volume, you still don't have IQOS. So do you think you need to divest some of these markets? And especially those markets where governments are not inclined to give any tax incentives towards RRP transition like Ukraine or any of these markets?

So first of all, for the skeptic, who would say, are you moving fast enough to reach 50% in 2025? I think you're not going to find, in corporate history, a lot of example of a company moving away from a core business that was doing well, profitable with leadership position and having the objective in such a short period of time to move predominantly to another business. So I think that it's a bit difficult to be skeptical in front of what we are doing. Now of course, I understand the question of what does it mean for the CC business? And the answer to your question is, today, no, it's not on the agenda to sell some of the cigarette business today, because it's really important to remain a leader in cigarette business. It's important because it's still financing all the investment that we need to make to become a different company. It's really important because remember here, the mission is to switch smoker to better product. And if we are no longer talking to the smokers, if we are no longer in the retail with the tobacconist and that we leave the ground to the competition, it's going to be much more difficult for us to come with our better product, convince the smoker to switch, take the right share with the distributor, and we leave the ground to competition that will have one objective, which is to continue to sell combustible cigarette to smokers. So I think for all this reason, it's really important that we continue to be a leader in CC. And for as much as we want to keep the CC category, we want to retain leadership to transform this leadership into switching more smokers to our products.

Well, I think we have run out of time, Emmanuel. I can keep talking for hours here.

Same here.

But thanks a lot for your time.

Thank you, Gaurav.

And thanks a lot for giving us the opportunity to host you again. Thanks a lot.

Thank you very much. Talk to you soon.