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

Pamela Kaufman, Morgan Stanley's U.S. tobacco and food analyst. Before we get started, a quick comment on disclosures. For important disclosures, please see the Morgan Stanley research disclosure website at www.morganstanley.com/researchdisclosures. If you have any questions, please feel free to reach out to your Morgan Stanley sales representative. We have Emmanuel Babeau, Philip Morris' Chief Financial Officer, joining us this morning for a fireside chat. 2021 has been an eventful year for Philip Morris, which has continued to deliver on its strategy of transitioning the business towards smoke-free products. This year, PM had a CEO change, introduced its Beyond Nicotine strategy, made several acquisitions in the health care space and diversified its portfolio by expanding into new products like IQOS, ILUMA, VEEV and nicotine patches. The current operating environment has created near-term supply challenges for IQOS, but we believe the company's long-term growth story remains intact. And I'll turn it over to Emmanuel for some opening remarks. Thank you again for coming.

Thank you, Pam. Good morning. Good afternoon, everybody. Great to be with you. And of course, an important moment of the year. It's a great moment to catch up. We've been posting on our website a document that is going to support our discussion, so I encourage you to download it. And I bring your attention on the Page 2 and 3, which are our forward-looking and cautionary statements, please read them carefully. I'm going to go directly to Page 4 of this document where we are highlighting the key element that I would like to comment as a kind of introduction to our discussion, Pam. Certainly, I want to start with the fact that we are going to finish a great year 2021 and Q4 is happening as expected and that is enabling us to confirm our guidance for the year. I remind you what it is, we are targeting an organic growth of our revenue between 6.5% and 7% and we are targeting an organic growth of our adjusted EPS between 13% and 14%. We are also revising our ForEx impact for the year. We now expect a positive ForEx impact on the adjusted EPS of plus $0.14 and it was before plus $0.17. Globally, we are seeing, as you all have seen I'm sure, a lot of volatility on currency and we know that this could have a meaningful impact on our 2022 numbers. And just to give you an indication, if we were to use and apply the current ForEx to the whole year 2021, it would have a negative impact of about minus $0.40, 4-0. So just for you to have that in mind. Now entering into the detail of what is driving this great performance in 2021, of course, first and foremost. This is a continuation of a great performance on IQOS and on our reduced risk product business. And despite the IC shortage challenge, we see absolutely the continuation of a very strong momentum behind IQOS and Q4 is happening as expected, so we are able to confirm that we are targeting a nice improvement of the market share in all our key markets in Q4. We are indeed as we said, expecting an improvement in the user growth in Q4 versus Q3, so a better number in terms of user acquisition. We are confirming our objective for the full year of around 95 billion sticks for the IQOS business. And of course, great news are coming from Japan, where the launch of ILUMA is an amazing success in all parameters. I will be happy Pam, to elaborate on that in our discussion if you want, but that is clearly driving an improvement of the market share of IQOS and another one in a continuation of market share improvement in Japan. And at the same time, we'll be launching in Switzerland, so we have another market now we've been launching and the first news coming from the Swiss market are simply outstanding as well. So very, very pleased with that. Now when we look at our chip shortages, we are getting some better news for Q1. So we are getting visibility and more positive news on availability in Q1 that's good news. We don't have yet visibility on Q2, which is still an uncertain quarter and of course, we are still assuming that H2 is going to be back to normal. And therefore, there are still scenario, but to be very clear, this is a scenario among many other where more shortages could create disruption on user acquisition and on the volume growth. And therefore, that could [indiscernible] this scenario, once again, 1 scenario, among many others, that we could be at a lower level than the average targeted growth for the 2021, 2023 period. At the same time and following what we expect to be a great year 2021, we are indeed confirming our growth objective for '21, '23. I'll just quickly remind you what they are. We are targeting an organic CAGR for our revenue of more than 5%. We are targeting an average growth of our operating margin of at least 150 basis points, and we are targeting an organic CAGR of our adjusted EPS of more than 9%. So we are confirming this objective. Now moving to the combustible category. The category is showing some resilience. Of course, as we see the recovery after the impact of the COVID in 2020, and we are happy to see our performance improving as we progress through 2021, and we target to finish Q4 2021 at the same level in terms of market share or a bit above where we were in Q4, 2020. So clearly very good news. And globally, we expect H2 2021 to be significantly better than H1 2021 in terms of market share. When I look at the countries that are driving this performance, many name could come to my mind, but certainly, I would mention Indonesia, Mexico, Turkey, Ukraine or Australia a country where we are delivering good performance on combustible in the recent months. When -- now I move to other key elements for us in 2021. The fact that we have been through the year on a very regular basis and Q4 will make no exception, a very nice evolution in many countries on tobacco harm reduction and legislation. That for me, something that is absolutely crucial in our journey to unsmoke the world. And Q4, as I said, is not going to make exception and certainly, the landmark has been the U.K., as you all have seen for sure, announcing that they were considering actually refunding. So the NHS would refund electronic cigarette if it was a permanent way to move people away from combustible cigarettes. The fact that the country as important as the U.K. is going for such. I would say, clear action, I think, is very encouraging for the future. The COP 9 was taking place a few days ago and although we regret that it did not end up with more measures in order to reduce the combustible category, we are very much encouraged by the fact that many countries have been raising their voice to show their interest for tobacco harm reduction policy and we see that clearly as a positive and as I said encouraging for the future. The next COP, the COP 10, will happen at the end of 2023. We regret obviously that the presidential review on the ITC case did not reverse the ITC decision. We are going to continue to challenge the patent of BAT allegedly infringed and the 2 patents that have been driving the decision of the ITC are currently being reviewed by the U.S. patent office and please note that these 2 patents have been the 1 invalidated by U.K. court not that long ago, a few months ago. So we'll see what this USPTO review will give. Now obviously, we are working as we said on the contingency plan and among them there will be the possibility to have domestic production for IQOS in the U.S. But even in applying this contingency plan that will mean that IQOS will not be available in the U.S. for a few months after the ITC decision. Last element Pam, you mentioned that '21 has been an important year because we have started to build 2 great businesses, 2 businesses where we see great legitimacy for us given all the investments, the expertise, the innovation, the R&D that we have been developed and great potential. The first 1 is what we call the self-care wellness, which is whether through oral delivery or inhalation based on botanical, the capacity to deliver great well-being experience, better sleep, more energy, more focus and relaxation. We see there a great market where we can have specific angle and a great capacity. Clearly the acquisition of Fertin will help us in accelerating the growth of that business, but remember that Fertin is also helping us further strengthening our capacity on the overall nicotine business. The second business that we intend to develop is the inhale therapeutic opportunity. All this science, all this expertise that we have on inhalation give us a unique role to build invent, innovate on medication that will be inhaled and that can bring better health to people and obviously, the Vectura acquisition is a landmark in order to develop the business. That's it Pam, with my preliminary comment. I'm really happy to answer your questions now.

Thank you for the comments. So you touched on this in your remarks, you've indicated that the growth outlook for next year may fall below your midterm targets, largely driven by IQOS device constraints due to the global semiconductor shortage and we are now anticipating a potential sizable FX headwinds that could further constrain earnings growth. So based on your current expectations for supply, can you provide some perspective on how underlying earnings for 2022 are evolving? And it sounds like things may be looking more positive in Q1.

Well, yes, first of all, on ForEx, let's be clear. There was a lot of volatility on the currency. My expectation is that it's going to continue. The dollar has been generally strengthening on the expectation that maybe the Fed would act and change policy that we all have seen a lot of event in the recent day with a new variant that could change the game, so let's be cautious and let's monitor the volatility. I think it's too early to conclude on what's going to be the ForEx impact next year. Now on the shortage of devices, yes, we've been sharing the good news that we have better visibility on Q1, Q2 is still uncertain and I want to repeat that this scenario where the limitation in availability would have an impact on growth are not the only scenario, neither it is more certain to be very clear. I'm just saying it is 1 scenario among others, and it is our responsibility to say that this does exist. I don't think I can speculate more at that stage, but I want to say that at that stage whatever the scenario on the table, we are targeting another good organic growth next year. So it's not about saying it's going to be difficult to grow organically. The momentum on IQOS as I said stays extremely powerful and it's going to continue to be a big driver. I talk about our performance on CC that is improving and we will target to have another year of good growth in 2022.

Great, and you indicated that IQOS momentum has been strong throughout the fourth quarter. During the third quarter, you added approximately 300,000 new IQOS users. Can you give us a sense for how new user acquisition is progressing through the fourth quarter and how you're balancing acquiring new users with ensuring adequate supply for existing IQOS users.

That's the absolute priority. We of course, want to work on the loyalty of the existing IQOS users that would be extremely detrimental not to be able to keep them with us and deliver a great experience, so that remains the top priority. But at the same time, and as explained at the end of Q3, we did manage to have a better understanding of how to optimize our assortment and allocation of devices and we expect that to have positive consequences on our Q4 with as I said, a nice improvement of the user growth in Q4 versus Q3. I'm not saying we're going to be back to the normal, which is 1 million plus every quarter, but we expect to be materially better than in Q3 in terms of user growth.

Okay. That's helpful. So in 2021, you raised your outlook for industry volumes and your own volumes. Can you characterize the current operating environment and how you view the health of the consumer across developed and emerging markets and the factors that are contributing to the better-than-expected volume performance this year and how you're thinking about demand over the course of the next year?

Yes. Probably the good resilience of the industry came as a surprise. The first explanation without any doubt is the fact that there was a rebound in many countries following the impact of the COVID. There was certainly some impact still coming from restriction on border and limiting illicit. But fundamentally, I have a feeling that the reduced-risk product category is a big driver for the overall nicotine industry, if you want and there is no doubt that in 2021, there is a nice growth of the industry for nicotine in volume, I would say and for the whole nicotine market in value. We'll see whether this volume growth in '21 will continue in 2022, but clearly the success of the RRP category, the fact that an increasing number of smokers are switching for this category is a good support for the nicotine market in the future and we certainly take a positive view on the evolution of the market in terms of value and the more we are positioned on the category with high added value and high value content, the better we are. So of course, that put us quite positive and optimistic for the future. Now it's going to be still a mixed bag for a while and the recent news on COVID are going to continue to have this situation with market clearly having improved and a nice economic rebound that is probably has been helping, purchasing power, social moment, which we are back, let's see whether there are more impact coming from the brand. But the other thing that the world is getting used to that more and more, so I'm not sure it will have an impact. Other country probably still have potential for rebound because obviously, they are still impacted by COVID and probably we're going to find them in the new economy in the emerging country where that's probably where some countries still can have some rebound and sometimes nice rebound following the COVID.

And Philip Morris has been much more acquisitive this year than in the past as you focus on executing on the Beyond Nicotine strategy. Can you discuss the key attributes that were compelling about the businesses you acquired? And how you're thinking about leveraging their capabilities?

Yes, we are staying very focused and I think if you enter the detail of what we've been acquiring, it has been about building new skills in RP, and that has been AG Snus and then Fertin acquisition, which is really the 2 together is giving us nice capacity to participate in what we think is a category with a lot of potential in the future and we see growing demand for nicotine consumer for this product. So that's something that is absolutely, of course, fostering our RP offering and then there is the 2 businesses the self-care wellness, inhale therapeutic where we have internally some skills, some expertise, some asset already, but we need to enrich that and where we've been doing this bolt-on acquisition. There has been part of Fertin that correspond to that. There have been Vectura. I can mention OtiTopic in inhaled therapeutic, inhalable [indiscernible], which is going to complement the Vectura platform, if you want. So we stay very focused. These are these 2 businesses, self-care wellness and inhaled therapeutics. It is not our intention to develop other businesses. We are there because we see some Blue Ocean dimension there. We see unique angle and capacity for us and this is really how we've been building some inorganic investment in 2021. It doesn't mean that we'll do more in the future. But if we were to do more, that will be to keep building within these 2 businesses some more capacity, whether in R&D and innovation, in commercial capacity or in product pipeline, I would say that thing that we could consider in the future.

And so just to expand on that, are there other areas that you would like to strengthen -- where you would like to strengthen your non-nicotine portfolio? And should we expect to see more acquisitions in the near term?

Well, I believe really that according to what I've just been describing, the area that you have seen are the area where we may keep investing. And again, it's not going to come with another business. It will be to enrich these 2 businesses where we see strong potential. It can be as I said, building the pipeline of product that we can bring to the consumer. It could be putting together more R&D and innovation capacity or it could be route-to-market commercial capacity as well with brand commercial sales force. I mean these are the things that we could build whether organically in some cases or if it makes sense, see whether some bolt-on acquisition could help us to do that inorganically. So these are the kind of things that we could think of, but clearly, on the space that we have described and on which you see us playing already.

And then in thinking about your investment priorities for next year, how are you thinking about the level of investment behind reduced-risk products? And what types of initiatives will you be focusing on?

Yes. I mean we have a call that is very clear. We see amazing potential on reduced-risk product. We see growing interest from the consumer for this category. And obviously, we are talking here about long-term investment. So I would say whatever is going to be the landscape in 2022, can it have an impact, I would say, marginally on the investment. Yes, of course, because that would mean that tactically a commercial action is going to be [indiscernible], deployment that we are considering will not going to happen. But fundamentally, we're going to keep innovating. We're going to keep coming with new products, with new innovation that is going to be attractive to the consumer. We're going to keep growing with more commercial development, more capacity to develop on a digital basis, a great customer experience. All that is not going to change. So you can expect us to be adjusting, I would say, marginally, depending on the situation and what we see, but fundamentally because we are surfing on a very promising and powerful wave, we're going to keep investing and investing for the long term.

Makes sense. And then can you talk about what you've observed from the IQOS and ILUMA launch in Japan? Previously, you indicated that it appears that it's appealing more to existing users. Have there been any changes that you're making to your marketing strategy to drive new customers?

So it was absolutely expected that a large chunk of the ILUMA buyer would be existing customers, but we see with great pleasure the percentage of the ILUMA buyers becoming more and more and growing becoming new users. So we are [indiscernible] we are north of 20% of the ILUMA buyers being a new user, and it shows the capacity of attraction of ILUMA. At the same time, we see a nice growth of the Net Promoter Score. So the customers are clearly more -- and enjoying more, if you want, the ILUMA experience versus our previous product. And we're not surprised because we know that our new products are killing the remaining pain points that we could have with our previous IQOS version and we talk about a significant improvement of the Net Promoter Score. We are 20 points better, that is very significant. And last but not least, we see a full conversion number, conversion number improving in a very material way. So people using ILUMA are better converted than people using our IQOS 3, for instance. So it shows it's another way to show the power of IQOS, ILUMA. And all that, of course, will translate into a nice improvement of our market share. We report at the end of 2021 where we are, but we are really hopeful to come back with very good news on that respect.

And then just shifting to the nicotine pouch category. You've made several investments there through the acquisition of AG Snus AG and Fertin Pharma. Can you discuss where you are in commercializing nicotine pouches and your strategy in this category?

So we are working on designing great products that are going to be available in the course of next year. We are still finalizing the launch plan for next year. And certainly in February, I will be happy to come with a clear view on where the markets where we're going to launch and what's the road map for that. So bear with us, but we are going to make of 2022 a year with certainly good inroad on nicotine pouches.

Right. And now just shifting to IQOS in the U.S. Now that the U.S. trade representative has upheld the ITC's decision. Can you discuss what the next steps are in this case and what the status is of the case in front of the U.S. Patents office?

Yes. So as I said, the first thing is that we're going to challenge certainly validity of the patent on which the ITC has been basing its decision. As I said, these 2 family of patents have been invalidated in the U.K. The U.S. PTO has accepted and it's already a first positive sign to review the validity of this patent. We see what is a decision, but that's something that we're going to pursue. At the same time, as I said, we are working on contingency plan and domestic capacity for producing IQOS in the U.S. is, of course, one of the contingency plan on which we are working.

And then just to kind of dig into the contingency plans around domestic manufacturing. What would be a potential time line to producing IQOS here in the U.S.? And what would be the approach? When you produce at Altria's plan -- any detail you can sure would be helpful.

Yes. So we're still working on the plan, and we'll see what is the most efficient and we believe that us having the capacity to produce in the U.S. would make sense. For the time line, we're still working on it. So it's too early and it's premature to come with the time line. We need to make sure we come with something that is reliable and on which we can deliver. So at that stage, I cannot give you a time line. The only thing I can say is that in the best scenario, that will mean a few months, certainly with no availability of IQOS in the U.S.

And what are your plans for bringing ILUMA to the U.S. and also what would be a potential time line for PMTA applications?

So we'll review for each of these devices. I think the plan is to have a PMTA file for VEEV sometime next year. I think for ILUMA, there is no decision yet and you know that before filing, you need to have a number of of data, and we always want to work in a very professional manner with the FDA that itself is working in a very professional manner. So when we're ready, we'll do that. So the time will come. With VEEV we think that '22 should be the year. With ILUMA, we'll see, it's too early to yet give a date.

Got it. And then is there similar cases that BAT has filed against Philip Morris outside of the U.S. Can you give an update on where those cases stand in Europe and where Philip Morris has been successful? And have there been any adverse decisions?

No. Actually, at the ITC case is the only case in which there has been an adverse decision. In Europe, it has been [ 12 ] decision in the row whether in trial or in Appellate that have been favorable to us. In the country -- I mean, several countries, but you have Bulgaria, Romania, Greece, Poland, I mean it's -- It's a full area of country where we've been winning. And of course, the U.K. once again where a court has been invalidated these 2 family of patents that are the one on which ITC has been basing their judgment. So outside ITC, It has been victory across the line. And I think it shows how robust our patent portfolio is.

And then shifting gears to combustibles. So this year, pricing growth of 2% to 3% has been below your historical mid- to high single-digit growth and you've indicated that you expect Q4 to be softer due to challenges in several markets and tougher comparisons. Can you talk about how you're thinking about the backdrop for combustibles pricing next year? And what puts and takes are that influence the pricing outlook?

Yes. So it's still a pretty blurred picture given the situation. I would have said probably that the COVID, the post-COVID situation and the economic impact would mean that increasing price in a number of geographies and notably in the emerging country will have some limitation. And I still believe it's going to be the case in some of this market. At the same time, we clearly see inflation that is gathering momentum and that could mean opportunity to increase price in other countries. So we'll see exactly what is the landscape. I think it's a bit too early to say in February, we'll know more. But certainly, we do intend to come with some nice push coming from price increase to our revenue. The good news, Pam, is that we used to be growing price, lot sometimes to the detriment of volume and today, we want to have a much more balanced evolution on combustible between price increase, but also, as we said, we try to defend the share of segment on combustible. But the good news is that next to price increase, now we have another very powerful driver to drive the difference between the volume evolution and the revenue evolution, which is a positive mix that is coming from IQOS and the consumables for IQOS. And that means that we are firing on 2 cylinders: Price increase and very powerful mix coming from heat-not-burn. And that is what is giving us anyway this capacity to have this nice differential between volumes and revenue.

And then just on combustible volumes you have seen improving market growth this year with the market percent in Europe, a recovery in Indonesia. Can you talk about your expectations for the combustible category next year? And the difference is you're anticipating across markets?

So you're right. As I said, good resilience this year of the combustible business. probably a mix of, as I said, recovery after tough 2020 in some markets, still a number of borders, illicit flow that were blocked. It's still very difficult given the uncertainty and the volatility in which we are leaving to say what's going to happen in 2022. So you have various option on the table, could the category resume its growth, decreased the trajectory that we've seen before. Are we going to see more impact whether positive or negative coming from COVID? Frankly, it's too early to say. I just have the feeling that -- looking at the CC today, we'll have to be done at the same time as looking at the RP category because clearly, RP category and the 3, heat-not-burn, vaping and nicotine pouches, they are growing their volume and their share of nicotine as a whole. And the robust growth that you have here is, of course, influencing the combustible category and globally starting to have a nice contribution to the evolution of the nicotine market as a whole. So let's watch for what it's going to mean in the coming years, but it sounds like a positive evolution.

And then the Philippines has been a challenged market for the last several years. Can you give an update on the dynamics that you're seeing there and what your expectations are?

Yes. Philippines has been a tough market, very much impacted by the COVID crisis and we have been increasing price here and all that has been making clearly some negative impact on our volumes. Now the good news that with the price increase, we are close to stability in terms of revenue growth. We see our market share stopping its decline and we can be hopeful for 2022 to show a rebound for combustible with the COVID impact debate. At the same time, we are launching IQOS and the first data on Manila are very positive. So we see great potential for heat-not-burn in this country. Let's see how fast we can grow that business in 2022.

And then earlier this year, you announced a $5 billion to $7 billion share buyback program. Year-to-date, the company has only bought back about $170 million in stock. What conditions are you looking for in order to accelerate share buybacks?

Yes, we said it, it's $5 billion to $7 billion over a 3-year period. We're not going to rush it. It's not going to be the kind of regular amount every month or every quarter. We're going to be tactical and making sure that we take benefit and we are there when for any reason, there is some pressure in the financial market. So bear with us until February when we announce our Q4 buyback and then you will see what we have been doing. But you have to expect us to be over the 3 years, progressively doing the being certainly tactical and trying to make sure that we are there when financial markets are difficult, share price is under pressure. And no doubt that today, for instance, we see our share price under pressure for reasons that we don't understand and that can mean that it could be an interesting moment for us to intervene. But bear with us until February, you will see what our action on Q4 has been.

Great. And then can you talk about your outlook for heat-not-burn taxes globally? A number of countries like Germany, Japan, the Ukraine have increased heat-not-burn taxes. How has that impacted new user acquisition and profitability?

Sure, Pam. Well, actually, I have to say that so far, I mean, you're right, there is Germany that is going to move to a 20% differential. So Germany and Japan more or less with the same differential, but I don't think there is anything else strikingly material to report at that stage. Of course, we have probably until end of December, maybe beginning of January to see that, but it's not as if there was many other countries where we're hearing that we could be facing a very negative evolution, I would say, of taxation on RP and heat-not-burn. And at the same time, as we've been reporting, we've seen a number of countries like Egypt, Pakistan and it's a discussion in Philippines, defining the heat-not-burn category with a very good tax differentiation reflecting the better product that these products are for nicotine users. So I think it's something that we're going to keep monitoring. But at that stage, I don't have anything new and bad to report.

That's helpful. Well, we are running up on time. I want to thank Emmanuel for joining us today, and thank you to all the listeners on the line. I hope that everyone has a great day and feel free to reach out with any questions.

Thank you, Pam, for listening here. Thank you very much. Talk to you soon.

Talk to you, you soon. Bye

Thank you. Bye.