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Is Phillip Morris' Weak Volumes a Concern for Tobacco Firms?

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Philip Morris International Inc.’s PM not-so-impressive first-quarter 2018 results gave investors cold feet, yesterday.  Well, Philip Morris’ results were mainly dampened by declining shipment volumes across some of the key market regions, thanks to lower cigarette sales.

The hurdles and their persistence were evident from investors’ bearish stance on the stock that fell 15.6% yesterday, slipping to a 52-week low of $83.50 and closing at $85.64. Per sources, this single day plunge counts amongst its biggest in almost 10 years. Apart from giving a jolt to Phillip Morris’ investors, softness in the cigarettes category also sent ripples of fear in the industry, dragging shares of other major players as well.

We note that the Zacks Tobacco industry has been sailing on rough seas, due to regulatory hurdles in the form of limitations on marketing, anti-smoking campaigns and higher excise duties. These factors have taken a serious toll on cigarette sales volumes, globally. Apart from this, rising health consciousness among consumers around the world lowered cigarette consumption. Indeed, such limitations have hindered the growth of the Tobacco industry that lost close to 17% in the past six months, versus the S&P 500 Index’s gain of 5.3%.


 

Coming back to yesterday’s debacle, let’s delve into the factors that led to such a nightmare for the company.

What Hit Philip Morris?

Disappointingly, during the first quarter of 2018, Philip Morris’ total cigarette and heated tobacco unit shipment volume fell 2.3% to 173.8 billion units, caused by declines across most regions other than South & Southeast Asia Region (S&SA) and the East Asia & Australia Region. In fact, all regions other than S&SA witnessed substantial decline in cigarette shipment volumes. So much so that even doubled-up increase in heated tobacco unit wasn’t enough to pare the declines witnessed in cigarettes, on an overall basis.

Further, the company’s operating income slipped 2.7% on a constant-currency (cc) basis, due to adverse volume/mix, especially in Gulf Cooperation Council (GCC), as well as escalated marketing, research and administration expenses incurred in respect of reduced risk products (RRPs). These hurdles couldn’t be fully offset by favorable pricing. Also, adjusted operating margin, at cc, fell 4.0 points to 35.8%. Further, the company’s currency-neutral bottom line dipped 1% in the first quarter, from 98 cents reported in the year-ago quarter.

Meanwhile, Philip Morris’ net revenues surged year on year. Expected gains from tax reforms also encouraged management to raise bottom-line view for 2018. However, these factors were not enough to placate investors who were gravely concerned with poor shipment volumes that led to the company’s fifth consecutive top-line miss.

Apart from this, management’s comments regarding the ongoing performance of certain regions  are likely to make them jittery. Incidentally, management continues to stay apprehensive regarding soft volumes in GCC, difficult pricing in Russia and sluggish sales in Japan.

Will Other Tobacco Players Follow Suit?

Altria Group, Inc. MO, slated to release first-quarter 2018 results on Apr 26, could not escape the domino effect of Philip Morris’s weak volumes. Evidently, Altria’s shares tumbled close to 6.1% yesterday. Like Philip Morris, Altria too has been grappling with receding shipment volumes in the smokeable segment. Notably, volumes in the segment declined 2.6%, 2.7%, 6.1% and 8.7%, respectively, in the preceding four quarters. Moreover, due to persistent declines in the cigarette category, Altria’s top line lagged the Zacks Consensus Estimate in eight out of the last 10 quarters. The company carries a VGM Score of F.

Moreover, British American Tobacco plc. BTI and Vector Group Ltd. VGR saw their shares decline 4.7% and 1.1%, respectively, during yesterday’s trading session. British American Tobacco’s organic cigarette volumes declined 2.6%, which was reflected in its preliminary results in February 2018. Vector Group, carrying a Zacks Rank #4 (Sell) also witnessed a decline of 2.8% in tobacco unit sales volumes in the fourth quarter of 2017 results. The company carries a VGM Score of D. You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

Any Hopes of a Revival Ahead?

Philip Morris, Altria and British American Tobacco, all carrying a Zacks Rank #3 (Hold), have been sternly focusing on the growth of RRPs. In fact, RRPs are rapidly gaining traction, considering their less detrimental impacts on health. With prolonged focus in this category, Philip Morris is pioneering the radical shift from harmful tobacco products to scientific and low-risk product alternatives. The company carries a VGM Score of B and has a long-term growth rate of 10.1%.

Altria has been radically expanding its RRPs portfolio. Furthermore, Altria’s marketing and technology agreement with Philip Morris is expected to boost the businesses of the companies. British American Tobacco has also been striving to expand in the RRPs realm with its Next Generation Products lineup. Although Vector Group has not ventured out into RRPs, the company relies upon the real estate segment to offset tobacco sales related hurdles.

Wrapping it up, RRPs seem to be one of the most viable options for companies to stay afloat in the tobacco industry (ranked among the top 38% out of more than 256 Zacks industries). However, such advancements are yet to completely offset cigarette sales declines, as the smokeable category accounts for a considerable chunk of revenues for most of these players. That said, let’s wait and watch what lies ahead for the players in the tobacco space and whether their efforts will revive the lost sheen in the stock market.

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