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

Good morning, everyone. Thank you for being here. I'm Palab Mittal, Head of Global Tobacco at Barclays. I'm thrilled to have Jacek Olstrak here with me, CEO of Philip Morris. Thank you so much, Jacek, for giving us this opportunity to host you. We will start with a few comments from Jacek, and then we'll move over to Q&A. Over to you, Jacek.

Thank you. Thank you for having me. I guess we are recovering from a long weekend, at least in the U.S., some recovering just from a judluck. So everyone should have a bit of a forgiveness. The standard slide in the beginning, including the forward-looking and cautionary statements, which as always, we encourage you to read. And earlier today, we issued a press release revising our full year guidance for currency only. So now we're cruising at the spot rate, the favorable currency impact of about $0.24 at $0.24. We also give an update how we see the currency impact on the Q3 results. So we're turning into $0.01 the current spot rate favorable. I mean there are a few big ticket items, if you like, which are happening this year, at least for PMI. One is obviously the tax price change situation in Japan. As you remember, the prices taxes, excise tax went up in April 1. Now we're going into second stage of second stage of the tax increase and the price increase. The prices has been registered by all the main players, including us. So we have a visibility how it's going on. I have to admit that, obviously, in a country when the prices is not happening very frequently, the absolute amount of the price increases, I mean, it always create some sort of a shock wave at the market at the consumer level, especially that this time we had -- this year, we had an asymmetry between a heat-not-burn category and the cigarette category. There is one more excise increase in the near term happening as of April 1. This will touch also cigarettes and heated tobacco product. But I think so far, the market is category is doing very well if you consider the magnitude of the changes which the consumers have to go to. So that category is resuming to the growth. Obviously, there was some sort of loading, the loading, pantry loading by consumers level. This whole thing has stabilized what we have seen over the last period before entering into October increase. I think it's all going in the right direction. Okay? There will be for the full year, we're still aiming at on the net adjusted basis, IMS growth in Japan, obviously, at the different levels that we used to have in the past. I think if the category goes through this magnitude of changes, so April now October and the next April price changes, I think it all goes well for the future of the category. As you remember, about a year ago, the category of this year, the category has exceeded 50% volume terms, volume terms of the total nicotine market. Japanese market is essentially combustible cigarettes and heated category. IQOS somehow holds the very high share of the segment despite the fact that there were different pricing strategies, if you like, tactics applied by the competition. And IQOS is at the high end of the market at the premium, but actually, it went very well. So this is an IQOS. Second thing is obviously U.S. And over the last couple of months, 2 months, as we announced as we were guiding the market before, we have expanded the portfolio of ZYN and our flagship pouch product into the moist version and the higher nicotine. This goes under the trademark of under the label of ZYN Ultra. A short period of time, the market has introduced more than 20 SKUs. So obviously, there is a massive effort on building a distribution, but also a massive effort to communicate this change to the consumer because from one day or another in many accounts, all of a sudden, the portfolio rapidly expanded. So consumers have to find out what is this new in terms of the nicotine strength but also the flavors. There was more things coming into the market as we speak. But our strategy for the U.S. on the pouch market is very clear. We'd like to obtain a sort of asymmetry in the market, our portfolio versus some other products, some other brands, also having in mind that this historical price premium, which the ZYN was carrying from the time which essentially was by far the only player in the market. So despite the fact that we believe ZYN can carry the premium, but we need to adjust the premium to something which is more manageable. So we're doing this also while we introducing new products to the market. We're doing a conversion from a 15, which is a traditional pouch count in the U.S. market. We're going to the 20, creating some extra value to the consumers, which I believe is going to help tremendously already is helping ZYN today what we see from at least the last period's performance, but very much it's going to support the future ZYN growth in the market here. So we're very pleased with the development. Obviously, we are watching carefully the FDA and how this regulatory environment is playing out. We're getting more and more clarity. Are we in the perfect situation? Yes, we are not. So we happy with what we have today with all the PMTAs which is in our portfolio have received absolutely, yes, because everything adds to our -- adds the clarity, we can construct the plans more solidly going forward. Now on the combustibles, which are doing on the face value, be better than one could expect from the past. But if you zoom in into which markets, et cetera, the combustible volumes are doing better than expected. I think there is a very strong correlations to the markets which do have some sort of a significant penetration of the smoke-free products versus the markets which do not for very much regulatory reasons, don't enjoy the consumers can't enjoy the access to the smoke-free product. So I mean, clearly, these volumes, better combustible volumes are coming mainly from the markets where SFP smoke-free products are not allowed or not marketed and not commercialized. And it somehow also reflect the underlying dynamics, the demographics, et cetera, population growth, GDP and some other factors, which we all know. But having said so, yes, the category is doing a bit better than we thought. It's nothing from our side, nothing wrong with this one, but our focus was on this and will be on the smoke-free product and opening the new markets. And obviously, U.S., which is a very big, very great opportunity in front of us, but also the markets in which we already have a significant position. I mentioned Japan, but very much Union European Union. There's also the pockets of geographies when the unit profitability is more attractive than the rest of the world. And that's for me. I guess you will have some questions.

Sure. That's some very good context, and we will go into the details on IQOS, thin and combustibles one by one. But if you could just start high level and as IQOS and ZYN and smoke-free penetration continues to increase, what we have seen over the last few years is you have had low double-digit, low teens EPS growth. Do you think that growth is sustainable over the next few years as you expand in the market?

That's our midterm algorithm and I believe it's a very -- it's attainable algorithm. And obviously, the quarters may differ, et cetera, but if you take a bit longer outlook for us. I think we can deliver in these ranges. Now this is all based on, I mean, the major shift which has happened at PMI over the last good few years. We started the smoke-free implementation of the smoke-free strategy about 11 years or so ago, as we remember, Japan and Italy. But very important is that we brought the whole company volumes into the growth. And actually, we're shooting for a sixth consecutive year of total volume growth. So I think we start delivering a much better quality of the revenue growth that we used to have when we were very much the combustible cigarette company. We all know the algorithm in the past. There are a few things which we retained and the current past and the current performance proves that we still command quite a pricing power, if you like. So there is a pretty solid pricing coming from combustible cigarettes year-over-year. But also there is some pricing coming from a smoke-free products very much from the category -- heated tobacco products category. Obviously, to the different extent because the dynamics is different and the strategy is more into go after penetration, grow the segment, maintain leadership or establish a leadership position in the segment. So you need to balance the share aspirations, volume growth aspirations and the price somehow in this equation. But both categories, combustibles and smoke-free products are contributing to the pricing variance in addition to the positive volumes. So this is very good. So if you look down from the top line, the rest is -- well, we know that this is not the extremely CapEx, if you like, a heavy category, the margins at the gross level are very attractive. And the rest is essentially the reflection of the strategy of how far we want to go and open or penetrate, as I said earlier, grow the leadership or solidify the leadership in the category. It's very much -- if you like, discretionary marketing type of spend, which depends on the elections we make in a given period, may go up, may go down. So I feel pretty confident that the earnings to the bottom line is going to grow and we're going to hit our algorithm. But also we don't try to be feel that the algorithm is somehow too much of a straight jacket, which would impair the company's ability to react to the market situation opportunities, challenges on a much shorter period of time. And this is how we play this whole thing. I should mention one more thing because I talk about the pricing, and I spent some time explaining Japan. So we have a tax increase price -- sorry, excise-driven price increases, high magnitude. Japan has changed the system of taxation. We call it the equalization to the CC, but in the combustible cigarettes, but in exchange, actually heated tobacco categories gaining now a price productivity, which is equal to the cigarette because in the past system, despite the fact that the category was enjoying lower taxation per unit, right, than the cigarettes, the price productivity was actually not very incentivizing the addition of the pricing to your growth mix. So essentially, as of now, the price product -- essentially, it means that for a given unit of the tax changes, we don't have to increase the prices so much. So if we increase more is returned to the company.

Right. So going into some of the details and starting with iQOS, clearly, it is on top of investors' mind in terms of the growth story. In 2016, we have seen a couple of transitory headwinds, call it the flavor ban in Poland, the excise tax increase in Japan, as you were highlighting. So going forward, in the second half of this year and then 2027, do you think it is fair to assume that you get back to the $15 billion sort of incremental stakes every year a fair expectation to have?

Yes, we try to guide the market more from how we see the total volumes of the company, Robert be very specific as we know in many countries, we have now we call multi-category strategies. We don't stay shy of introducing the electronic cigarette into the IQOS users portfolio. So thing we feel very positive on the total volume trajectory. Now IQOS, I mean, a few of the -- I mean, they're always in the history of IQOS, we go back again to what has happened over the last 11, 10 years. there were always some headwinds, okay? There were the flavor bans majority very much in the European Union. Majority of the countries has gone for this whole thing. I think one of the largest countries when we had the exposure on the flavors was Italy. And as Italy went for the couple of months or quarters of a bumpy road, and you look at the growth rates of Italy today. if you wouldn't know that there was a flavor ban, you wouldn't notice this from the volume performance, both for the category and for IQOS. So Poland is one of the what is the large flavor market and the last market from the large markets in the EU, which has to go for this transition. I mean base what we have observed in other European markets, yes, I mean, there will be some sort of shorter-term headings, but I don't think it's going to change the attractiveness of our category in the mid to longer term. Yes, excise, look, the taxes, we are in the nicotine industry in the past, we call it just the cigarette the tobacco industry, but we need to broaden this whole thing. It's not that we like the taxes, but the taxes are something which doesn't keep me awake for the too long in science I've seen -- we've seen some manages country-by-country year after year. This is something built into the way we're managing the business. What we always were saying, and I think this is true also in a smoke-free category that there is an ability to manage the taxes for the prices as long as they are becoming sort of a regular event and over some sort of a moderate level of increases from time to time, you always have the one country, one gather men, which tries to do something and ototodocs and like Mexico recently, you have a period of years of no tax changes, some price changes driven by manufacturers. No tax changes in the detax doubled. So I mean, that's the shocking type of is the sticker shock at the consumer level. And then we need to somehow moderated impact but may be partially absorbing may be taking some prices, some price increases ahead and I catch up later on. I mentioned Japan again because that's the most recent event. With this massive tax changes in Poonenot-bearin category after our pricing, which we announced as of October 1, we essentially passed through plus some margin improvement in the market. So I think we had that capacity and I mentioned how IQOS and the category is performing. I think we're going in the right direction. The rest of the market is still my numbers are right in quite a significant absorption, but we managed through iQOS vehicles or to pass it through. So the headwinds that they are saying that this is the waters are flat and they are pretty choppy waters on occasions there, but we operate on a truly global basis. always, you have a market which you're having a very nice surprises. The market reactions, the fiscal regulatory and there are some markets which might have some hiccups, and we just have to go for this call.

Right. If I can just talk on the Japanese heat not burn market. So I think this year, you're still expecting the market to grow despite the excise tax environment. And then from next year, tax increases for cigarettes and heat not burn will be pretty similar. So should -- do you expect strong growth to return to heat not burn IPOs in Japan from next year?

Well, there will be some volume impact, right? I mean today, we have this misbalance that hit the tobacco products to the price cigarettes days. So obviously, cigarette is the only sourcing, if you like, full of consumers going into the heated tobacco products. So there is a temporary sort of a price disincentive to go and instead of paying whatever an per bag of cigarette. I have to pay EBITDA more for a bag of there, okay? We have a set 50 lower, but still it's an upper part of the market. But I think all these things should somehow wash out either now once we will have a assuming whatever pricing rate will happen in April. But this is the first time that the cigarettes will go up. So I think a consumer thinking will somehow incorporate this into that decision. What I'm saying is despite the fact that there was this massive imbalance price increases on a heated products compared to cigarettes. And I still see how the category is performing so far. I mean assuming nothing will be broken in the second part of this year. What then the next year, the situation is even better. But from a total overall consumption level, well, I believe the loss of elasticity somehow will kick in. We need to now see how much they're going to impact the heated category versus CC category. But I think, again, from a financial performance perspective, not the volume performance perspective, as Japan has a pretty attractive fiscal multiplier, i.e., how much you can retain from a given price increase into the company's margins. I think on the revenue, we should be fine.

Right. Before we move into nicotine power, just on IQOS luma in the U.S., is there any update in terms of the PMTA time line? Because last time I think when you were talking to the market, you said it is pretty close. Any update on that would be great.

No. I made this in the past public events like this one, I make this not a mistake, but I was offering time lines, and I were always wrong. So I refrain from referring to any fortune talent regards. So when we can hear when we can get authorization for Illuma from FDA. I guess the longer weekend was also on the federal level. So I guess the agency was not working over the long weekend. So let's leave it like this. I think lately, we are -- in my view, we are -- it's shorter, it's sooner than later. The fire lease with FDA for the long time. I know that there are conversation discussion with EBITDA. But until we have a PMTA then you'll come to anything. But our focus is on executing the strategy I mentioned what we have launched into the market over the last 2 months, that's the quite impressive portfolio enhancement. So now we are busy. We're putting in back to the -- on the growth trajectory, recover the share at least to some extent. And we're busy with this one. I mean I case are ready already because we have all this international experience, et cetera. So it's more the questions as of when we can bring it to the market. I still believe that heated tobacco product cycles, in particular, as the undisputed global leader has the room to play here. I still confirm that I see it over a period of time, heated tobacco products can take, say, a 10% of the combined cigarettes and the heated product. This is what we've seen in other markets. But it's not that I'm trying to develop here some different unique scenario. I mean, essentially, the average sort of a performance IQOS has achieved a group all the markets in which IQOS is present today. By the way, I mean, the U.S. is the most developed, if you like a nicotine market. If you'll take in consideration all the product categories and emanations which you have okay, some so-called list, some lease it, that's more the issue, which is on the regulatory side, very much on a vague to the much, much lesser extent on the pouches because the legal market is more developed, thanks also to some FDA decisions. But I think when IQOS will come to U.S., I mean, print-speking IQOS will be category on its own right? So I think that advantage is still from this opportunity still in from the IQOS. I think whenever we'll get these authorizations, we are ready to go and introduce IQOS Illuma to the market. Remember that we have authorization for IQOS. But due to all of this latency of FDA, et cetera, of the long-lasting process, we ended up in the situation that technology for which we have IQOS version based on the technology, which we have the full-fledged authorization and nothing technically stops finances to the market is the technology which we essentially retired on international. So not only in the consumer good space, we would expect U.S. to be a bidder at par or a step ahead on innovations to the market, and now we ended up in a reverse thing. So for us, to be very frank, it doesn't make sense to go to the previous iQOS and got it here if we still have invited IQOS, the latest world come. By the way, the Illuma will not IQOS Illuma will also not last forever, and we're already gearing up for -- without disclosing too much of the details, we're gearing up for the next big thing from IQOS. So we cannot afford recycling on a global basis, a very fast technology, past technology and the latest model technology. So sure internally is extremely difficult.