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

Good afternoon, everyone. I'm Gaurav Jain, Barclays Head of Global Tobacco. With me today, we have Philip Morris' CEO, Jacek Olczak. Thank you so much for giving us the opportunity for this fireside chat.

Good afternoon.

So PMI stock is currently trading at all-time highs. The last time PMI hit $120-plus was in 2017. And that was a time when IQOS had just launched and was growing rapidly in Japan. Year-to-date, PMI's stock is up 35%, ahead of S&P Staples Index, which is up 16%; and S&P and NASDAQ, which are each up about 20%. Now PMI has been a very difficult stock to own at times over the last 10 years for various reasons, particularly FX and also investments associated with its NGP transition. But despite all of that, today, its 10-year returns are in line with broader staples index. So now the question for all of us is that can PMI from here on systematically outperform S&P 500?

So this is the question?

No, this was -- just setting the expectation that I think all of us have. So the first question, just going back into history when PMI split out of [indiscernible] in 2008, it used to talk of volume growth and 10% to 12% EPS growth without share repurchases, and it was growth driven by emerging markets. And now we are talking about volume growth again, which is driven by high profit pool markets like U.S. and Europe and also driven by NGPs, which have better unit economics. So do you think that we can look back and actually a 10% to 12% EPS growth and even north of that, like 12% to 14% because growth is now driven by NGPs?

Well, it's actually good way to start because when I recall I was that time CFO, I recall it very well almost what was the first growth algorithm for PMI. So you may recall, especially those of you who follow [indiscernible] for a longer period of time. At that time, growth algorithm was 3% to 5% on the top with the flat to slightly decline in volumes. Obviously, there was a lot of pricing contribution at that time, translating to 6%, 8% and OI level. and 8% to 10% on EPS, no buyback. With the buyback, we've been able to lift it to 10%, 12%, and this is what we were delivering for quite a few years. I remember the early conversations when we opened a smoke-free category very much [indiscernible] that what does will -- what will it bring to PMI from a growth profile perspective going forward. And at that time I volunteered that I think we can lift the numbers by the good 2 points of growth across all of these metrics. So here we are good 3 years later, and you could see that the volumes for the last 3 years, which is very difficult, is almost impossible in a classical tobacco cigarette industry to be at the flat, I mean we are actually in a growth combined volumes despite the fact that obviously, there was an underlying trend on cigarettes amplified by the cannibalization to our own heat-not-burn platform, but we can lift it all to the positive territory. Revenues are growing in -- at the mid-single level we have a good quality, again, coming from a volume mix, which enhance the margins of the unit revenues and the margins. And there is obviously the pricing, pretty strong pricing, I would argue, on the cigarettes, smaller for SFP, for smoke-free products, the categories in different stages of development. And then we can deliver with the reaffirm guidance, which we just issued today, 11% to 13%, no buyback, right? So pretty strong results compared to where we were a good few years ago. And I think there is still an ample room for growth going forward. I mean you know very well that for the last almost 2 years, we are back to the U.S. where on the back of acquisition of Swedish Match with ZYN, which adds very nicely to our profile growth on all metrics. I mean the margins are very attractive, products clearly delivers on the promise of a smoke-free, better alternative to cigarettes and there is a growing market essentially in every -- almost in every place in the world unless, for some unexplainable stupid type of reasons, the products are banned, while cigarettes are being alone. But other than that, you have a growth in every geography. So this year, I think, will be another confirmation that this transformation was not only very attractive, obviously, from a smokers', consumers' perspective, but equally very attractive from an investor's perspective because, I mean, at the margins, we're looking for the margin expansion, importantly for us also in the dollar terms, not just on the adjusted tax currency basis, we're looking in a very strong -- very, very strong Q3 results. So every fine -- every quarter starts bringing us more and more confidence until, your question, should we expect more? I mean, definitely, there is a room for PMI to continue with the current growth, which I would argue is very strong. But we're also trying to use every opportunity to enhance the growth profit. Reentry to the U.S., sorry, it's a bit long. But the 1 thing, and that's very much we all know it, which was behind the sort of, I guess, share price performance always is more difficult as insider to explain it is the currency profile of PMI, right, which will -- the underlying results of PMI on the new products, but also on the cigarettes were extremely strong. And the question was that if the currencies were going against us, it was difficult to lift it -- to lift it in the dollar terms. But I think as we all see, I mean the currency are starting to adjust in the different directions, positive to us. So I think if we address -- and we're also increasing our profile by the presence in the U.S., not maybe in a very substantive manner, but it's better than we used to have before. The pricing come strong, et cetera, so I believe not only we can deliver a very strong adjusted ex currency basis growth, but very importantly, also the dollar growth. And as you know, it's very important to us from a cash flow perspective. And you know very well our strong commitment to the dividend. So obviously, we're very much aligned, I guess, with the market expectations.

So just going to the volume growth, which is happening now for you, and it is being driven by some of these high NGP penetration country. So we are seeing market volumes stabilize, particularly in Japan, Italy, Scandinavia, all regions where NGP penetration has reached 20% plus. So do you think this is the right conclusion that NGPs improved secular volume trends? Or these are just some aberrations happening?

No, I believe that -- okay, this is all the NGP markets, the smoke-free products markets, right, by category, okay, we're obviously very much focused and they occupy a lot of our -- quite rightly, a lot of space in our conversations. But these categories are still in the very early phases. I mean obviously, the youngest one is nicotine pouches that in the U.S., which obviously is the point of attention of many of us. I mean the category has not even a scratch or is scratching a 5% level. So it's in the 95% of the market is in a different form than pouches. Okay, heat-not-burn is a more advanced in many geographies e-vapor, but still majority of the product in any geographies in a conventional form. But what do we see that each of the products being heat-not-burn, e-vapor, and very much a product like the nicotine pouches, they offer adult smokers, different opportunities compared to the cigarette smoking in terms of the moment of consumption. And I think that's the one underlying factor behind the growth of this category in addition, obviously, to the switching. I mean it's pretty obvious. I'm not disclosing the rocket science here that they are more constrained when people would be free from a societal pressure perspective or from a regulatory perspective of using a cigarette. But definitely, these pressures are different and attitudes are different if you go to the heat-not-burn, e-vapor or the pouches, right? The pouches, which obviously are the most discrete. So it's very fair to assume that this will translate into the different consumption patterns going forward compared to the beginning, if we take a cigarette -- combustible cigarettes as the beginning of the category. So I believe the volume outlook, the way we measure, right, the volume outlook, I think it's pretty -- my view is very positive, obviously, for the companies like ours, when you take a lot of first-mover advantage and you're building the brand and you create the category, it's obviously harder from a perspective that you need to take a lot of efforts on your organization, but also the returns are very nicely rewarding you for the first-mover sort of a strategy. But the volumes, I think there's a lot of -- I think over a period of time, we might be looking at the industry from a completely different volume perspective that we remember this from a combustible product. But the products which offer is completely different harm profile, I mean, these products are significantly reducing the exposure, as you know, we know all to the harmful compounds you find in a cigarette smoke. So there is clearly the benefit compared to continuing smoking. And smokers users are singling more freedom in terms of how I can interact how I can use the product.

Sure. So on our math, your volumes will be positive even if you start increasing cigarette prices, which historically you have increased 5% to 7%, if you take that algorithm up to 7% to 9%, that would lead to some market share loss. But then you will gain share through NGPs. So net-net, you will still be positive on volume share. So the question is that are you at a point where some of the countries you can now run on a total nicotine volume share basis, which means that one of your key KPIs, which is flat cigarette market share globally is not met?

Yes. Okay. Let me translate your question, Gaurav. We're asking can we do more pricing?

Yes.

Okay. So here's the thing, we don't pay attention to market share, I'm talking of combustible part of the business, but not to the extent, obviously, that in a category which we all know in our view, the destination of this category that we should be too much worried about the market share, but not to the extent just to do the pricing, which will accelerate our declines. Because still we will have to remember the category offers attractive margins, right, in the consumer space. The second is a very strong cash flow, which is associated with these margins and these cash flows are very important to -- for a number of the corporate needs, including, as I mentioned, our commitment to the strong dividends, et cetera. So that's the one thing. Does it mean that we are not really -- in many markets, we are the market leader, then we will don't shy from taking the pricing in the market. Even if you like last year or this year, right, what is baked into the guidance, we come in with a very, very strong pricing variance even including in the dollar absolute terms, taking enough consideration -- sorry, this pricing variance in absolute terms will be higher than the pricing variance we were turning in the past despite the fact that we saved quite a lot of cigarette volume. So we're actually delivering much more absolute terms, dollar absolute terms pricing variance than in past despite the fact that we have less underlying cigarette volumes. So that's the one thing. When it comes to the share on the total nicotine space, okay, by the fact that you're growing in pouches that the fact that you're growing with the heat-not-burn and also recently with e-vapor, I mean, obviously, our share will go up. So we have to -- our ambitions are much higher. But look, share is very important. But I remember one of my processors used to say, "I can't pay the dividend for market share." So you always have to bear in mind what is the value behind that share. And yes, we do focus on maximizing the value on the cigarettes on our business. Share is secondary type of the measure. We will not abruptly react to the 10 or 20 basis points type of a movement, but we will not do the pricing, which will, all of a sudden, start collapsing our positions in a marketplace.

Now investors think, and moving to IQOS, that investors think that PMI has been routinely bullish on IQOS and then had to adjust guidance down especially on volumes. So do you think a change in approach to IQOS cost guidance is needed now where you have reached in terms of scale on IQOS and its share in your business?

So then investors will tell us that well of [indiscernible]. So they always go in this bag and fourth type of a conversation. I mean, yes, we had -- it happened to us that we had to adjust the outlook for a given period for IQOS, but let's also take it, I mean the way I look into this is you're taking $1 billion, a couple of billion of adjustments in the final volumes you're delivering for a period, right? Usually, your -- there are a number of other factors at play rather than something which would -- we should be worried about the longer term. So yes, I mean, sometimes maybe we should be more precise going forward than a factor number of the moving parts, more in parts and know it very well, in addition to -- every new consumers to IQOS is gain for the near time, right? But they never did the smoke-free transformation before, and we cannot be arrogant that we know with all though is a learning with the first cohort of consumers and the second cohort of consumers, et cetera. I remember that we had a few years ago, a bit of a slowdown in Japan, and everyone reacted very nervously. If you look from today's perspective, where is Japan, you would essentially consider the event of some years ago as just the blip, which we shouldn't really react and definitely not overreact to this whole thing. By the way, Japan, and we have said it at the beginning of the year, volumes of heat-not-burn category, obviously, very much driven by IQOS, in Tokyo crossing 50% mark. And I think everything indicates that if we continue like this, Japan will be the first market next year, 2025, you will have a more volume of a heat-not-burn than the cigarettes. So the progress is there and the growth is there. I think the challenge which we have is we're not really debating where there is a growth. It's more the question of, is this growth going like this, so what is the angle of the growth, right? What is the rate of growth? And we had an EU situation, right, with the ban on the flavors at the beginning of the year, maybe it was not as stronger. There were some pressures in Italy. But if I look at the Q2 or current performance of Italy, it seems that we're going back where we wanted to be, et cetera. So some of these factors is difficult very accurately estimate, if you like, assess and said, okay, this is what it is. And usually, also try to come with a guidance, which is not what I call the Swiss pharmacy with the second digit after comma type of the thing. It's 140, it's 140. From my perspective, where we delivered 139.5, 141 to be very frank from a scheme of the things the same number. I understand the value of another $1 billion, but this is more the question, do we observe a consumer trend changes versus the past, i.e., people are trying and adopting the product, the people happy with my product, with my brand, brand -- does my brand equity goes up? Do people keep on referring my product to other? And if a score well and over these parameters by definition, I will grow the volume. How much, I may be under or overestimating this whole thing. But this is not, I think, something which personally, I would be very worried about.

Sure. And can you, in that context, just remind us of the impact of the EU flavor ban on high cost this year? And I think the comments that were made on the last call was that 2025 should be better because things should accelerate so -- for IQOS in EU. So can you just remind us?

Yes. So we're looking at the second half of this year, right, to be stronger than the first in terms of growth and seems that -- looks that we're going into this direction. So we are fine with this. We have estimated that the challenge with the flavor one in Europe is that it is not the 1 day or 1 week when the ban is being implemented across all the European markets, right? So different markets have a different timing, different sequence. So that's a little bit puts the extra pressure, if you like, given on our own estimates. We have estimated at the beginning of the year that the impact in 2024 might be in the range of about $2 billion. Presumably, it will be $2 billion point something. I mean, a couple of few hundreds more millions. But the more the question is what do we observe in the market, which relatively earlier have entered into the -- or implemented the flavor ban, and what is the time they're returning to the growth comparable to they used to have the whole? So if we look at the Central Europe, I mentioned Italy, and this is coming back. So our assumption that flavor ban has some time sort of an impact or temporary type of an impact, it's difficult now to say how long is temporarily. But seems it's supported by what we observe in the marketplace. So you go for this distortion. And I'm not just talking consumer demand because there is demand, which is -- sorry, demand meaning consumption. But this demand, these people know, consumers know that the product will be banned, they're buying more, trade is taking different actions. So it's a lot of -- some level, not a lot, but some level of distortions in the marketplace. But I mentioned, Italy seems that they're regaining the momentum from the past, okay. That's okay. Central Europe, I mean, Czech, et cetera, a few other markets, we're going for this whole exercise. So the situation, it seems that they are on a good path. There's a different rate of the growth in a different market, but there is a growth and it goes in the right direction. From the large markets when there is still a relatively high propulsion of the flavor product would be Poland, the sizable market. But the Poland, I don't think they're going to implement anything this year, Italy, presumably the end of the year, but not nothing now. So this will be more in 2025 next year event.

Sure. Now quickly moving to ZYN, where the success in the U.S. has been clearly phenomenal, but currently you are constrained on capacity. Now you are expanding capacity. You have given us some numbers, at least on gross CapEx at your prior call. So you have lost some share. And the question is, as your capacity expansion happens, how confident are you that you will gain back the market share?

Well, we must have some level of confidence, otherwise, we wouldn't announce in the span of 4 weeks 2 capacity expansion plans. It means we would make a mistake somewhere else. Colorado, which we announced first Aurora in Colorado is more or less the greenfield, which will come in 2 years' time into the chain, into the supply chain. But we also obviously have the Ownesboro, and Ownesboro is the existing -- Kentucky existing current Swedish Match operations, right, the only manufacturer in the U.S. of ZYN product. So we max out, -- we're now maxing out what we could do with Ownesboro. That's the 900 million next year. So this year, you know what is our guidance on the volumes. Okay, 900 million capacity, obviously, for next year assumes the growth, and I believe that growth is there. Now we have lost, Swedish Match have -- ZYN has lost a few -- a couple of few percentage points on the market share, but it's very interesting, especially if you follow news and other market statistics is that since the unfortunate out-of-stock situation with ZYN, the entire category growth has stopped. It is different, it lost the dynamics, which it has before, which tells me that this was a ZYN who was actually -- which was driving the category not just any other products in the marketplace. So there is a bit of saving of the -- lots of the share going to some of the competitors' brand. But this is in a range of a few percentage points, okay, 4, 5 presumably. But the category has stagnated now ups in the ZYN continuous and unconcentrated supply. We will unfortunately be with the situation because before we get to this 900 million capacity next year, I mean this will not happen as of January 1. There is a time to get there, but I think -- sorry I wanted to say that the 900 million, out of phrase it properly that I manage the expectations. That the growth might be obviously beyond the 900 million. And if that happens and faster than we think, then we may be in the constrained situation beyond Ownesboro expansion. This is what I wanted to say. And this is the Colorado expansion, but from a timing perspective, we don't know how it's going to last. So shall I am more comfortable that we'll get it, now is the question is how quickly we can put the entire category because since that ZYN was the carrier of generating the growth of the full capacity.

So with such strong growth in ZYN, then I guess the concern that investors have is youth uptake, and there is a lot of conflicting data points, which are floating around, and we will have the FDA's youth tobacco survey out probably in the next month or so. But even beyond this youth tobacco survey that, let's say, even if there is like low prevalence in this survey, what are you doing to actively prevent youth uptake?

Yes. So look, the whole conversation is about you have access to the product, you have access to the or exposure to the marketing communication about the product, I mean something from the very beginning than all of us on tracking PMI we're taking very seriously, right? I mean, you know how we -- everyone knows how we execute in IQOS into market, no type of issue whatsoever. FDA and others, obviously, know, I mean it's all transparent, et cetera. ZYN obviously creates a lot of unnecessary excitement, very much driven via social media. I think what we're doing on the physical access to the product, I feel very strong about this and being the assistance of the retail networks of the retail shops, et cetera. So access, physical access to the product, it's actually very doable to have a strong grip on. Obviously, you always may find one or two independent general type of retailers, but you can send themselves for the lease account. And you have quite a lot of imports on pressure points on that. Contrary to the access to information, especially with the prevalence of the social media, et cetera, on the user-generated content is becoming more difficult. So even if a PMI and a Swedish Match have a very strict policy, not the influencers of age limit for the model you use in an advertising [indiscernible], et cetera, and these are very well-known documented, et cetera, practices, which we have, the one thing which is difficult for us to control is what is, what exactly are the conversations in social media, not triggered by us, not triggered by the brand, but just triggered by the users. We're reaching out the social media companies for their help. I think there is the room for some moderation, et cetera. Some of these conversations depends on the followership, which some people have should be a little -- should be more restricted just not to expose not to the product, but to the information about the product. So I think the practices, which is Swedish had before, obviously, now as the part of the Philip Morris Group, et cetera, they're -- I feel very confident. And these are the things which are known to important stakeholders. But obviously, it's a public perception, and we all have to be very careful. This on the nicotine containing products, et cetera, et cetera. These products are not for under-age people. And they were not designed for them. And the audience are the adult smokers. This is what we should focus. So I think we have the things under control. Obviously, absolute zero doesn't exist because you always will find the one retailer however, who will be on compliance, but you have a pretty good path to control it. The other things, what we're doing is also protecting the market from access of products, which are not authorized by FDA. So you all know it, Swedish ZYN has the pending PMTAs. And by the way, in Q2 of this year, we filed a MRTPA for our ZYN product as well. So on the regulatory side, we obviously awaiting the FDA decision, but we're also protecting the market from a diversion of the product in the format, which were not -- which are not subject by even the pending PMTAs from outside, which also demonstrates how responsible we are in controlling. You've heard we shut down pretty fast zyn.com, the Internet site supporting the e-commerce sales, as the reaction of some situations in D.C. So I think we're always -- it's not that we demonstrate, but this is what we do. If we see that something is going out of the hand, I mean our company can act very swiftly and we have the full force to address the problem.

Sure. Now coming back to the comment around share repurchases that we were making earlier. So you are clearly well north of your 2x leverage target. And the comment that has been made at times is that you will start buying back shares when you will have a line to site to 2x leverage. So is it that, let's say, you're levered at 2.3x, but do you see yourselves going to below 2x next year, you will start share repurchases or you will actually wait until it goes to like 1.8x net debt to EBITDA before...

Yes. So there's always a everyone knows it's always up to the Board, right, to authorized or not to share repurchase. But I think we are on the good path post the acquisition of Swedish Match and deleveraging. And I think that outlook, which we have said that we should be in about 2-ish type of a territory somewhere in '26, especially when you take this year that we are reaffirming that, okay, strong growth, but also expansion in margins in the dollar terms, et cetera. So I believe we are on a good path to be in this 2-ish type of a territory '26 and that is the moment. So some are the visibility of this whole thing you will have in '25. And I think this is the period which we'll start to consider. But remember, this is pretty obvious what they're going to say. But share buyback for us was always up and the other uses of capital. Obviously, dividend for us is very important. We have demonstrated even in a little bit under pressure, especially from a dollar perspective that we'll focus on dividend and go with the dividend above what the dollar earnings would indicate. And I think we drove it to the right territories now. So dividend for us is very important. Share buyback, as I said, is the Board and absentee uses of cash, just formality.

Okay. Now one of the criticisms against PMI historically was that the dollar EPS didn't really grow. And now because of the growth in your U.S. business driven by ZYN, you can certainly -- I guess you can still have some ranges around FX, but you can definitely think about a minimum dollar EPS growth or some sort of communication to the market that you can actually grow dollar EPS number at this number despite whatever could happen in FX. So is that something that you might think of, let's say, minimum dollar EPS growth of 5%...

Yes, I mean, we have quite a few KPIs, right, for which the company is measured, assessed and -- including me and my executive team, et cetera. So obviously have a cash flow. So you have a dollar type of measure, and you have a few other measures. I don't think we would go into the direction of changing. I believe it served us pretty well for this whole period with the focus. Obviously, we have said that by the fact that we committed so large to the rewarding shareholders primarily through the means of a dividend. And obviously, it's not just the dividend and its growth, et cetera. then obviously, you go straight to the cash flow and dividend is in dollar, so your cash flow in the dollars have to cover all our needs and obviously, for the dividend distribution. So somehow if you like, directly or indirectly, the dollar focus is there. But having said so, and we said that -- I said the number of occasions that there is a good environment from the pricing, right? We started with the pricing because of the excise type of environment, you don't have abrupt and this proportional type of an excise increases. So this obviously is the good block on which you could build the pricing strategy. It works. That obviously helps a lot also from a dollar -- in dollar terms of the revenue and the margin, what we're bringing home, but pricing, making a domestic market pricing decision based on the currency, the currency exchange rate may also be a very bad idea, right? So if you take a yen historically, now yen goes other direction, so it's a lot of strengthening. But consumers are spending money in the local currency, okay? So if you exaggerate with the pricing driven by the exchange rates, you will end up with a pricing in the market, which completely doesn't feed into what is the disposable is the power of the purchasing power in the market. So you need to balance this cultic, which doesn't mean that you can still not optimize in a search and look for the value to achieve the ultimate objective, which is keep on moving our performance measures, our performance numbers in the dollar terms.

And with that, we are out of time. We have a breakout as well. Thank you so much, Jacek for your time. And the breakout is right around the corner. So see you all there. Thank you.

Thank you.