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

Good morning, everyone. Thank you for being here. I'm Gaurav Jain, Barclays Head of Global Tobacco. I'm thrilled to have Jacek Olczak here with me, CEO of Philip Morris. Thank you, Jacek, for giving us the opportunity to host you.

Good morning.

We will start with a few comments from Jacek, and then we will move over to Q&A.

Yes. I will not take much of the time because Gaurav has the long list of questions here. So we may need to have a day to go through all. But just a quick one, as always, the forward-looking cautionary statement, you are supposed to read and get familiar with those. We -- earlier today, we issued a press release reaffirming the guidance. So we will -- we're shooting at the closing of the year and 13% to 15% growth on EPS level. I think just as a retrospect because we are in this smoke-free transformation for more than 10 years with the results, which I guess most of you are well familiar with. This is our strongest growth since 2011 when obviously, you take out the post-pandemic COVID recovery. There is a strong [indiscernible] continue. I mean we're shooting into the figure on the positive volumes for the total business. And this is despite, obviously, that we're putting ourselves a combustible business under pressure by pushing and being focused on a smoke-free product. It's a matter however, this is a heat-not-burn pouches, so they vape. But this yields the results. I think in the tobacco and nicotine industry, having 5 years in a row of the continuous positive volumes, obviously, that's to the quality of the revenue as the strong pricing very much on the combustible cigarettes continue, and we're looking into another year of strong prices -- strong pricing. And it is also supported by the relatively good tax or fiscal environment, and we don't have any disruptive tax increases and outlook. Even this day, somebody can talk about an outlook, but seems that -- there is nothing as a significant headwind at all coming there. So this obviously gives this quality of revenue in this industry and for us very much where you have a volume mix which is coming from the product. You know very well that the smoke-free products are much more accretive both on the top line, but very much on the gross margin level and at the bottom line. And obviously, our recent reentry to the -- or come back to the U.S., obviously multiply the margin profile and -- the unit revenue and the margin profile. So this is how we aim at closing the year. Just from the last update, which we gave at the second quarter earnings release, we continue to see a strong IQOS growth, very good international volume growth and the geographical expansion. I think ZYN is already in 47 markets. So we're adding a few markets per month per quarter. Obviously, the category is still very small, but we all know that it has a great prospect, and we're very pleased that our entry into electronic cigarettes, and this is the third year and we're going to the e-vape product is still yielding the right results. We have mentioned in the Q2 that we might have some issues around the combustibles, mainly we quoted 2 geographies, Turkey and Egypt. And the way I think with -- so far, we're going for the Q3, I think we will be, as is written here, better than expected. So with all things together, we may actually come with a stronger total PMI volumes that we have highlighted at the end of the Q2. ZYN. So obviously, all eyes and the attention is on the ZYN in the U.S. as is obviously, in Philip Morris. There are 2 dynamics which we observed there. One is something which is not really very much strategic, but we just have to go through this whole thing, which is to normalize the inventory levels post the very long period of the out of stock and the limitations on the supply driven by our undercapacity. You know very well, capacity now is in the right shape. We have a ton of room to grow. But I guess the inventory at the trade level will somehow have to normalize, and I expect that we expect that somewhere in the Q3, the final is going to be behind us. Now inventories obviously are the result of what is happening on the back end in defense what is in offtake. So obviously very closely happening the market situations at the retail level and what I can say, and I think it was even in my quote -- we put it in my quote on the press release. I mean, we do observe intensified level of competition when we talk about the ZYN U.S. I can talk later on about other places where the competition is intensified. And this resulted that somewhere when we've been at the end of addressing out of stock and start shipping more products to the market, the price gap between ZYN and the second or the third competitor in the market has opened to the very high level because we're talking today about the price situations when the ZYN is 65-plus percent on a per pouch basis, higher price than the next competitor. So you can read it. So obviously, our reaction is that now having a full supply of the market, we're giving up the marketing and the promotional support to put ZYN on the track of growth, which would meet our ambitions, our expectations. But there is another way, if you want to look into this whole thing that the ZYN has survived the last 2 or so quarters with this intensive competition opening that price premium. This actually, from my perspective, tells quite a lot how strong ZYN as the brand is because if I use the parallel to the premium propositions, which we have on the cigarette category by Star, Marlboro, which is a great blend globally, not ours, but it's a great brand in the U.S. I mean, Marlboro would not be available to attain such a price premium versus the key competitors as we have with the ZYN. And by the way, we have IQOS and International. So it tells me that we're doing an excellent job, a very good job in a brand building because that's the brand which gives you this pricing power, price premium. However, some of these price gaps have to be addressed, which we're doing as we speak in Q3. I mean, the rest, I mentioned. I talked about the pricing. The smoke-free, obviously, for the mix contributes positively further enhance the margin profile. There will be margin expansion this year. So I think a couple -- some time ago, we had a bit of a hiccup with the margins. And I know there was a point of attention by some of investors, but I think these things are behind us. Needless to say, but that's somehow a common thing in this industry. There is a good cash conversion, cash flow generation which obviously helps a lot because this creates the platform for a continuous investment for the product development and a lot is still needed, but also generates a good platform for the investors, for the shareholders' returns. There are a couple of other things which happen. You know that we still have a few markets when the smoke-free products in total or heat-not-burn category are banned. We had a couple of good developments. Finally, Taiwan is opening the market to heat-not-burn. There was Malta in Europe and a few other geographies. So it's like every quarter, despite the fact that some regulators are not really following the science and the logic, if you like, but they're finally getting on our side and opening the market. So this is net positive. It presumably will wait more '26 than '25. But every time when we achieve another milestone is important to us. So that's from me. We can go to your Q&A.

Sure. Thank you so much, Jacek. And let's just get into some of the details on ZYN because that clearly is a big question in investors' minds. So 2H '24, PMI shipped, if I remember correctly, 314 million cans of ZYN. And assuming that shipment was the same as sell-through in 2H '24, then essentially what you are suggesting is that whatever our assumptions are on sell-through growth rate for 2H '25, we should apply it on 314 million, and we will come to the 2H '25 shipment number. Is that the right way to think?

Yes, it is with the difference that -- sorry, with one comment that this is the assumption, right? So things may summer this year, and I think in Q3, we'll have to clean up and now everyone guesses that we have excess of 1 or maybe 2 weeks of inventory. So if you take this and now calculate the total annual shipments or sell-through, you're talking 20 million, 30 million, maybe 35 sort of million cans. This is not that much of [indiscernible]. This is assuming that the trade here would target, say, about 3 to 4 weeks of inventories. Now different trades has different policies on the working capital, et cetera. But this we know that we are a little bit still on the high end in the earlier situations, we should clean it up. The more important is how much the marketing and promotional activity will now give the boost to the brand at the retail offtake level because this is the more important question because the inventory is a washout, okay, Q3 for the remaining months of the year. But you little can do about this next year, right? It's a retail trend, which is going to flow to the next year, and this is what's going to translate to our financials.

Right. And you mentioned that ZYN is at a price premium of 65% and ZYN on a per pouch basis?

On a per pouch. You remember ZYN, we're selling ZYN at the cans of 15 pouches per can, the market is under 20. So when you see the prices at the retail, obviously, premium on a per can basis, but the premium per pouch basis is even higher. And there is -- my reading, our reading of the situation is that coverage of the intensity of the promotional activity by competitors is about 60% -- 50%, close to 60% of the volume is covered by the different sort of promotions. When we started Q3, ZYN was at a much, much lower level, right? So now we're gearing this up to start matching what is the market situation. But as I said, ZYN has had a great growth rate from the Q1, Q2, which also tells me that there is much more into -- behind ZYN which can withstand such a challenging pricing environment. But it is what it is. We just have to go and fight for our presence and for our share, nobody said that our return to U.S. will be walking apart.

Is there a price premium in mind that you have, which is...

No. Well, then I would start disclosing the things which I don't think I should even if you torture me. So I will not go into this territory. But definitely, ZYN is the premium as is IQOS, et cetera, but in other places, right? But I mean, the 65% is on an extremely high end, okay, it is also realistic. We also have to take that the more people go into -- more smokers, adult smokers or consumers go into the category. Obviously, if people are acting -- are looking at the value equations into the whole things, I guess, and the product has some limits in terms of relative pricing, which you need to take into consideration. But we -- I know there is a lot of interest. There's a lot of, obviously, focus and attention at PMI. But I just want to remind everyone that all smoke-free is extremely exciting and oral, which is oral category, especially pouches, right, nicotine pouches are extremely exciting because this is like a new thing on the block. But U.S., which is the most developed nicotine pouch market, I mean, the total nicotine pouches market in the U.S., it's say, 6%, maybe 7%, depends what statistics you start using. I think a big question is what is happening to the 94% of the market, okay? Plus/minus less than 0.5% is cigarette. There is still a lot of other smoke-free products in the market. And if you remember from one of our presentations before, we said from a data we had on ZYN and is taking from oral, the classical oral, which is relatively logical and obvious, but it's taking from a vape, it's taking from a cigarette. So I'm trying -- also at PMI, obviously, you need to focus on what you have with the 6% category today. But the big question is, can category be 12%, 24% or 48% because that's the prospect. I think direction which this category is showing that people consider oral vis-a-vis inhalables, including combustibles inhalables, is extremely highly encouraged. I mean, we have a few markets in international. I'm not talking Nordics, which was the whole tradition, which also have a very promising, exciting development. But if I take the U.K., which is presumably in Europe other than Nordics, Sweden, the most developed market, I mean, the barrel has been scratched up to, I don't know, 1.5% of the total market. But if we see now the insights from the consumers, the level of attractions, the growing awareness, trial and so on, I think more exciting is what is left, what is not still in the category, what is in the category. I understand you need to build your base and hold you -- build your positions from what you have today. But I think the smoke-free in general is the phenomenal opportunity which happened in front of this industry. And you can put, obviously, Philip Morris as the leader into this whole thing. But I think the industry is on the path for growth as long as you really start following the consumer, which is a smoke-free product and also understand one thing that the products that we have today, whether IQOS heat-not-burn or e-vape, which has its own problems, challenges or pouches, 5, 10 years from now may look completely different. But the common denominator is people want to continue to inhale the products, but with a different risk profile and the adults wants to enjoy the oral nicotine. And whether this is a pouch or anything else, this is the territory in which you play. There will be a lot of innovations. And remember, when we started IQOS 10 or whatever years, 11 years ago, how many innovations we had to roll through the IQOS, and this is just 10 years. And I always was saying that if I compare it to the innovation level, which you used to have on a cigarette when in the span of 60 years of the industry, you had 2.5 innovations, flip-top box pack and the filter, which you see the innovations which are going into this category, which, by the way, triggers materially important response from the consumer level is a phenomenal opportunity.

Now ZYN is a product which was created, you could argue before August 8, 2016, which was the deeming date while your competitors like BAT's Velo Plus, it's a product which has been recently created because it's a synthetic nicotine product. And Altria just announced 2 weeks ago that they will launch on! PLUS even though they don't have a PMTA. So your competition is launching -- one would argue the latest flavors, the latest products, while you are waiting still for the PMTA for ZYN Ultra, which nobody knows when it will come. So how do you navigate this competitive dynamic? And do you think you would want to follow Altria and launch ZYN Ultra?

There are all options on the table for these reasons, I will not talk about [ELYSEE] and which configurations will launch. I mean behind the ZYN, we had quite a number of pending PMTAs on the moist, on the dry different nicotine strengths and the flavors. And they are -- I mean, the most important or critical strategic post any date when the FDA issued in the normal course of the business rule on these things, but I will not comment whether we will wait for FDA or what I'm just reading following the footsteps of one of our competitors. I just think that this is another example to demonstrate how attractive this category is to anybody and how rational the market may go at this stage because, look, I think Philip Morris did a phenomenal job in a smoke-free when we opened the concept of harm reductions and smoke-free. We demonstrated and we continue to have a leadership in a heat-not-burn. E-vape has its own thing. Oral nicotine pouches is the third category, smallest, very dynamic partially because it is also smallest. And I don't think anybody can afford not trying at least to win in this category. So the level of competition will be there. But again, I think as ZYN has the first-mover advantage, I think as ZYN is the brand, we talk about the price and a few other aspects as is IQOS. It's a long term -- it's a long battle, but I think we're very well equipped to go for this battle. I'm not talking about the e-vape because there's a little bit more of the complicated situations, but I do believe that the demand for the e-vape is well grounded and will stay. The market will have to go and clean up a lot of things, illicit regulatory. There's a lot of misperceptions. I think 5 years from now, the situations will look different. The important thing is that cigarette smokers, adult cigarette smokers, there is a myth that they will migrate to the one category or the one product emanation. This monochromatic type of a category, which was one cigarette and [indiscernible] cigarette looked the same, branding was differentiating, now will be split into what we have today in the marketplace, which is heat-not burn e-vape and oral. There will be more innovations. There might be other ways of delivering the nicotine. It's all open and consumers will go and navigate into this one. And hence, we have been for the last some time talking that it is not just betting on one category. Actually, I think very smart is to play what we call the multi-category, and you need to have that presence. Because if you start taking -- first the game, I don't think the consumer will just jump to one. There always will be segment, very sizable segment. For heat-not-burn, there will be a sizable segment for e-vape and will have to be -- and there will be [indiscernible] in some places about to be a sizable segment for the pouches. And that's going to stay. And now obviously, if you operate at scale, it's one of the building block to your margin profile because obviously, the scale gives you the better view from a cost perspective. But also you have a lot of synergies because at the end of the day, you're talking to the same consumer. Your target audience is the same. It's a smoker. So you have synergies middleway through the P&L, but actually you have a lot of synergies at the top level.

Sure. Now moving on to IQOS. And I think investors have focused a lot on ZYN in the last 2 years and also cigarettes, while IQOS clearly had a flavor ban in Europe, which decelerated the growth rate and also Taiwan, which people were expecting would have come probably a year ago, hasn't come in yet. Now IQOS is adding about 15 billion sticks per annum for the last 2 years, and that is your guidance for this year as well. But if we say that the flavor ban in Europe is now largely through except for maybe Poland, one of the large markets and Taiwan comes in at some point of time, I don't know which month or year if you want to put when it will come, then does that suggest that FY '26 volume growth for IQOS could accelerate from this 15 billion per stick?

Yes. I mean, from the flavor ban in Europe, I recall it's still about 6 markets to go. The most sizable is Poland. You might have some -- again, some transitory type of headwind. But as you could see what is happening as we speak in Italy and other places, which went for the flavor ban. Over a period of time, there is a wash in this whole thing. So the consumer is adjusting and IQOS is going back to its past growth trajectory. I mean, 15 billion without going into any guidance for '26, right? This is still too early. I think 50 billion is a nice number throughout the geographies of everything, which will be open.

Right. And any date on Taiwan, like when will they start?

As we speak about it.