Philip Morris (PM) reported earnings on April 21 and reiterated the firm's commitment to its dividend during these uncertain times:
We also expect that strong cash flows will exceed cash requirements, including the funding of dividends to which we remain fully committed...
Crucially, our organization, liquidity, and balance sheet are strong. We'll continue to protect and support our employees, serve our consumers, and reward our shareholders, which clearly includes our strong commitment to a dividend.
The international maker of Marlboro cigarettes and IQOS heated tobacco products expects to remain relatively resilient overall during the pandemic.
In developed markets such as the the European Union (15% of shipments) and Japan (7%), which tend to have strong social support programs, Philip Morris has so far not seen any impact on consumption.
Management also noted that, technically, people staying home have more opportunities to smoke than when they are at work. And in periods of uncertainty, while people tend to buy lower-priced products, they are also more likely to trust known brands from safe sources.
From a supply perspective, the company does not anticipate out-of-stock situations in any major markets and generally expects consumers to have adequate access to its products.
With that said, Philip Morris has seen three negative effects on its business.
Philip Morris generates about 4% of its net revenues from duty-free sales, which have plunged due to government travel restrictions. This high-margin business will eventually bounce back as travel demand recovers, but it will remain depressed for now.
The company also expects lockdown measures to limit the ability of its field sales forces to engage with adult smokers about IQOS. The rate of new user acquisition is projected to be around 50% lower than anticipated for as long as government restrictions remain in place.
Management believes Philip Morris can still achieve its IQOS heated tobacco unit volume target of 90 billion to 100 billion sticks by 2021 if restrictions only last for the quarter. If they last for a year, then the firm may need to delay its goal.
Finally, in Indonesia (13% of volume last year), the government delayed the enforcement of a new minimum price from April until June due to COVID-19 restrictions. This was expected to impact retail prices at the low end of the market and reduce price gaps with Philip Morris's premium cigarette brands.
As a result of these challenges, Philip Morris withdrew its full-year guidance and will issue quarterly guidance instead. Management expects net revenue to decline 8% to 12% in the second quarter, wholly attributable to COVID-19 factors.
Once these headwinds pass, Philip Morris expects to resume growth consistent with its 2019 to 2021 annual targets of at least 5% net revenue growth and at least 8% adjusted EPS growth.
Prior to the pandemic, Philip Morris was executing well. Combustible tobacco pricing increased 7.7% in the first quarter as its brands continued enjoying solid pricing power. (Cigarette shipment volume was down 3.8%.)
Progress continued with transitioning the portfolio to reduced-risk products (RRP) as well. This part of the business is critical to the company's future as more smokers are expected to seek cigarette alternatives in the years ahead.
RRP revenue reached close to 22% of Philip Morris's total sales, with IQOS devices accounting for about 10% of RRP revenues.
Heated tobacco units grew 46% and now make up nearly 10% of the company's total shipment volume as compared to 8% in 2019 and almost nothing in 2015. Scaling this business helped drive the 5.1% increase in Philip Morris's operating margin last quarter, too.
While the long-term outlook arguably has not changed for the company, Philip Morris's financial strength positions it well in case the months ahead are weaker than expected.
As of March 31, the firm had $3.7 billion of cash on hand and $7.5 billion available in revolving credit facilities. Only $0.3 billion of bonds mature through the end of 2020, and less than $6 billion comes due between 2021 and 2022.
And if Philip Morris did require more substantial access to capital, its leverage ratio remains low (about 2x) and the company maintains an A credit rating with a stable outlook from the rating agencies.
Overall, Philip Morris appears well positioned to endure the pandemic and should continue generating solid cash flow. We plan to continue holding our shares in our Conservative Retirees portfolio.