Philip Morris International Inc. (PM) Q1 2015 Earnings Report, Transcript and Summary

If you could all take your seats please, we're ready for the next presentation. Thank you. I'm pleased to introduce Philip Morris International next up for our presenting companies today and CFO, Jacek Olczak to the stand. I'd like to very much thank Philip Morris our sponsorship of CAGNY including the break this morning so please join me in congratulating and thanking them for that. PM is obviously one of the largest global tobacco companies and has dominant market shares around the world. Its business fundamentals remain strong lead by robust price realization. The company is no doubt encountered a very difficult foreign exchange environment to say the least which is masking an otherwise solid performance in the business. In addition the company has launched some innovative products in markets around the world that have reduced risk profile that could serve to change its business in the category of the long run. So I'll turn over to Jacek Olczak now to talk more of those initiatives and his strategies for the business.

Thank you, Chris. It is a great pleasure for me to be back at the CAGNY Conference here in Florida. Let me extend a warm welcome to those joining us on the webcast. My remarks contain forward-looking statements and, accordingly, I direct your attention to the Forward-Looking and Cautionary Statements section of today’s press release, presentation and our SEC filings. Reconciliations of non-GAAP measures included in this presentation to the most comparable GAAP measures, along with a glossary of terms, are available on our website. Reduced-Risk Products, or RRPs, is the term we use to refer to products that have the potential to reduce individual risk and population harm in comparison to smoking combustible cigarettes. After a brief overview of our 2014 results, our success in meeting the key market challenges that we outlined at the beginning of last year, and our expectations for 2015, I will focus on four topics: currency exposure and strategies to mitigate its impact, our superior brands, led by Marlboro, the exciting prospects for our Reduced-Risk Products portfolio, and returning cash to our shareholders. In 2014, our adjusted diluted EPS increased by 7.8% excluding currency, surpassing the 6.5% to 7.5% guidance range that we provided in November. Last year, we successfully overcame our biggest challenge in Asia by stabilizing our market share in Japan. We achieved this thanks to our Be Marlboro marketing campaign, innovative line extensions and the morphing of Philip Morris into Lark. We are now poised to resume modest share growth. In the Philippines, cigarette consumption remained resilient and our volume was stable. In addition, retail prices at the bottom end of the market have recently increased, which is a very positive development. In the EU Region, there was a substantial moderation in 2014 in the decline rate of cigarette industry volume.…

Let’s start with Michael Lavery here.

Let’s start with Michael Lavery here.

Just looking at your organic growth it was roughly flat last year and the year before a little bit stronger, so can you point to a couple of areas where you see the sharpest acceleration that helps to drive how you expect to get to the six to eight organic EBIT and eight to ten EPS especially without buybacks and with the headwinds in places like Korea and the investment spending on iQOS.

Sure, thanks. The biggest driver which we had last year clearly coming from the Philippines in terms of the margin drive the top line flowing through the bottom line was coming from the Philippines, was coming from Japan, it was coming from Italy. As you have heard, you must have heard in our earnings call and in today’s remarks. I mean it was the hardest year -- hard year here for us, that’s PMI but we’re very pleased with what we’ve achieved and at the tone of the note in which we finish 2014. I mean, we feel we’re in a much better shape on how we address all of this market specific issues and none of them seems to remain any drag or any significant drag if at all. I mentioned in Philippines the situation is getting better as bottom the market finally took a while but since the tax sticker implementations and some of our governmental enforcement actions that bringing the result. Japan surely stabilized, the year was essentially, if not in Italy which we had this surprising tax issue, yield frankly speaking has five quarters in a row of improving total industry trends and this is very much also supported by other very stronger market share growth, not only Marlboro but L&M, Chesterfield, et cetera. And our e-markets has momentum clearly in Russia, is a country -- is a market on our watch-out list, But momentum from [human] momentum from L.A. I mean it makes us deliver that returning to 8% to 10% EPS growth this is something absolutely realistic for us this year.

And just one follow up on a Philippines as you talked about the pricing coming up with the bottom end and that's where most of the pressure has been, but the taxes have been going up on all the brands and the pricing at the top has been steady. Do you see upside for that as well?

You saw in our chart that the earnings release in today's remarks that the price drops in Philippines’ are significantly closed and that's the development of the last say two months, three months. So I believe once we will go into the direct territory when we’re comfortable with the price drops, I mean literally it is open on the pricing opportunity, we can't talk about our future pricing moves but about what drags us on the pricing is this, despite GAAP openings in the past. So once we recovered from that situation I think we've to look more positively into Philippines.

Thank you, just a quick question for you on Marlboro. I'm just curious, there are number of different factors that led to Marlboro's performance in 2014 and thinking like Japan and markets for there is some significant reductions in inventory, I'm just curious if the brand like excluding those factors if you know would it share, would have grown. I'm also curious like with Marlboro 2.0 and markets for which it’s been released, are you seeing like an accelerated market share growth is there such that you roll it out to more markets this year, you may see accelerating market share for the brand?

Well, I think the best testimony to the strength of Marlboro is that the growth of Marlboro in the EU region because if you take from a consumer perspective, the consumer is clearly not in a full recovery on a macro side and you can move the Marlboro up in terms of the market share. I think that's essentially the market, I think Marlboro 2.0 that's the commercial approach as the number of our initiatives which we took behind the entire brand architecture. Just to correct one thing. The inventories, the difference between the shipments and in-market sales in Japan doesn't have an impact on the market. I mean we have the decline of the Marlboro in Japan but Inventories movement doesn't impact that number. Philippines obviously was a drag for obvious situation, so we lost quite a lot of volumes in Philippines which has brought the share down. But I think it's not an equity problem with Marlboro in Philippines, completely other factor. So this one, we’re actually very confident that Marlboro should and will be growing in Philippines.

Let's go all the way this way, we'll come back at you. Let’s do Bonnie and then we’ll come back at you.

Okay, I have a question on how you're positioning RRP within your company over the long term. On one hand it's going to eventually cannibalize your combustible cigs business which generates very attractive margins, but then there is possibly an incentive fee to do this given the more favorable tax structure you might have for this product for many key markets. So could you just kind of walk through that for us in terms of how are you going to start this for the next few years?

Bonnie, it's a great question. Yes the tax structure are more favorable today, I mean we're paying Marlboro HeatSticks in Japan base about 15% to 20% lower tax than a regular Marlboro and it's even bigger tax differential in Italy and is obviously supporting the margins -- much more important presume here to beginning where obviously our cost are not where they will be once we will reach the critical mass, the [indiscernible] factory is completed et cetera. There is a lot of also cost when you launch the product first time in the market so this is helpful. We have said and made it very clear in the past and this is what we touched in top market so far. This is a product which deserves the premium positioning, so the price territory is Marlboro around Marlboro. That is obviously already gives you above average margins for Philip Morris, but also for the industry. So even if we just stay at that level that -- take the tax out of the equation and just look at targeted cost structure going forward, price positioning I mean we've product which is equally not better than the Marlboro going forward for the margin accretion. Now if I add the tax for the same than obviously that accretion is even high. Now our excitement at PMI, there is a tremendous excitement about this product in PMI is not only from the perspective of a unit margins because obviously we will have the product with a high unit margins but also I think with the potential of what that product can do for the entire category. So I think is the volume potential it’s more than just the unit margin.

Okay, thank you for that and just a quick question on Solaris, do you think that you're going to be rolling out in Spain that you just mentioned? Where are you going to price that, would be my first question and is it going to be the exact same product just with the different name than MarkTen or you making any modifications to that product or will there be any --?

I think it's basically the Nu Mark’s MarkTen technology. I think that product is I think if I compare this product to what is available in the market today, I think it would compare quite favorable to the most of the products in the market, we all know what is the inefficiency of the technology or short comings of this technology today. As you know we're working through come up with an improved technology, this is our just the first step in doing the whole journey. When it comes to price positioning you know Philip Morris, I mean I have not disclosed the price, but we usually like the higher pricing territory, there's no surprise for you.

Let's go to Judy and then we will come to you Matt.

Two questions. First so just thinking about Russia in 2015 as you think about your ability to achieve fixed 3% organic operating profit growth, how big a risk factor is Russia particularly as it relates to last year when you saw pretty strong price and profit growth in that market?

I mean that so far the momentum in Russia continues. I mean that Russia is not maybe on the risk side, it's more on the watch-out side. I mean there are many components which can come to play in Russia and to some extent only known to us. I mean it's the ruble strength or weakness, it's how that weakness of ruble is going to translate into the other macros in the economy, the [indiscernible] oil price has an impact on the Russian state budget and it's all this issue about the Ukraine sanctions et cetera, so you have a number of variables which are around or in Russia and we just have to watch it very carefully. So far, we are not observing any change in the trends in what we had last year. Okay so, the way I look at that thing is that, obviously PMI had this fortunate or unfortunate experience that it seems EBIT will hit, if it will happen, that this a second crisis in the modern history in Russia. We had that unfortunate experience to be a part of the first crisis, if I confer how do we stand today in Russia PMI versus that some years ago, I think our portfolio; our infrastructure is in a much better shape. Our distribution is better, portfolio is vastly better that we hedged this time, which I think naturally hedges your with the Parliament because we will always have that super premium type of a segment there, but obviously hedging give more -- should there be acceleration or sudden down trading et cetera [indiscernible]. So I think portfolio wise, infrastructure wise I mean we -- I think we should be okay. But there are few unknowns which maybe beyond our control, but so far we don't observe any change in the trends I mean look at the total market December, January I know is always distorted around the tax price changes but nothing which will spook me if --which will signal something wrong to me. Pricing was strong last year in Russia, I don’t see the reason why it shouldn't happen this year if tax structure clears, the government has a focus on [anti-releasing] activities, so none of these components has changed but the other externalities which we will have to watch carefully.

And then just on currency I really appreciate a lot of these disclosures that you have given on the local versus non-local cost. I guess as we think about some of the markets like Turkey and Russia where there is a bigger portion of non-local cost and acknowledging that some of that is leave cost that you can't really control, but are you actively looking ways of optimizing manufacturing footprint, overhead expenses to really line up more on the local cost side?

Yes absolutely we do I mean the last year we mainly talked about the [indiscernible] facilities, the European one of the largest facilities in Australia, but there were much more restructuring which we have initiated which will continue this year. Fierce revenue, we're continuously looking on the infrastructure installed and to making sure that this somehow goes parallel with the market demand with the capacity required. But you need to -- we are selling a quality cigarette regardless of the price segments in which we sell them, these are quality cigarettes and this is how those brands also have that pricing power. And I think that is starting to compromise because of the currency difficulties and replacing some of the critical materials with something which is cheaper may buy me a quarter or two but then I’ve lost the decade, so this is not our philosophy.

We will go to Matt and then we will come to Vivian.

I just wanted to follow-up on Judy's question first on the sourcing structure and cost structure and the one thing that kind of stood out to me is that there has been a very, very gradual shift it seems like it's becoming slightly more local overtime, but within that maybe there’s individual markets like Russia where if we look back five years ago I think it was 40% local resource cost and now it's 65%. So I guess first question is, what were you able to do there over the past five years which shifted the balance?

We have a more flexibility on some direct materials notably related to materials and obviously now you have the suppliers which also making their investment in the country, so you can bring their cost to the local. It's also I think overtime that some of the cost which in the past -- from the discretionary type of a cost which you only could procure from outside are being given services and then you can procure them today in the local currency. So the question is not on the phenomena in Russia but in many developing countries over a period of time you can see that the services, the labor supplies et cetera, I mean that you can make them available on the local currency.

Just a follow-up on the excise tax environment. The improvement that you saw in Italy I think it was an improvement maybe it was a little bit less of a shift than you would have hoped for initially, so I guess the question on Italy is, is that dialogue still open, can you continue pushing for ongoing annual improvement or should we not get our hopes up and then any other similar market for you highlight where you’re hoping for some -- to implements some change over the next year or two?

Matt I’m smiling because Italy is the country where you are in an ongoing dialog always, so you have to be in this ongoing dialog. I think it’s very important step, is always we’ve this experience in the past in Spain for example and in the countries which were very stable in the higher tolerance structures are not seeing the benefit of a more specific MET, Minimum Excise Tax structures, I mean the most critical element is to make the first step and once they go into this renovation this change the whole philosophy, the whole thinking about my tax revenues as a state, et cetera. So my experience -- our experience is always the most difficult is to make the first step, but Italy, believe me you have to -- dialog is critical in Italy.

My question has to do with Marlboro innovation, clearly it is a much bigger piece of the business today and its driven nice improvement in your market shares around the world and hopefully in stabilization of Asia specifically, but as you think about your innovation pipeline going forward do you need to accelerate the combustible innovation specifically around Marlboro as landscape gets increasingly competitors and then second to that how do you balance that investment relative to RRPs?

I mean it’s important is to bring the -- it is obvious what I will say, but it’s very important to bring the relevant innovations to the market and I mean you can burn a lot of money by throwing the things which don’t matter and much more like a promotional additions of the product there’s a lot of efforts, maybe you have a 10s of the points of the markets for short period of time and it’s not worth. Actually I think over period of time it rolls in equity of the brand, consumers don’t treat a burnt service. I think that Marlboro has a very solid pipeline of their consumer relevant innovations, being on the filter, being on there’s new mantle segment which has a lot of tractions in many geographies. The packaging -- I mean the things the [silk] packs et cetera, which protects the product from countries where the humidity is different, temperatures are much higher and it supports or enhances the product maintenance of the product quality. But it is also important that once you have the strong portfolio like PMI we can cascade this innovations to other brands, and so obviously Marlboro will very often will have the priority, but then we will not stay shy of deploying the same innovations maybe with some tweaks et cetera to Parliament , to Chesterfield. And that helps a lot because yes there is a cost of developing something new but later on I don’t incur that cost once I roll this out, so this is how we look at it.

And a quick follow up you mentioned the Japanese yen hedged at 60% of sales, is that roughly hedged equally across the four quarters of 2015 or is that?

Yes it is.

Eric and then Ann behind him.

With respect to Australia the competitive environment’s been difficult you’ve lost share in the low price segment so I’m wondering how are you characterizing the outlook for 2015 is this an area in which you’re going to deploy the new commercial approach is that something you see it potentially effective in addressing some of the problems you’ve had in Australia thank you.

I mean Australia actually on the commercial approach there are [indiscernible] for some time sales forces, there’s a lot of key accounts trade cigarettes for all the Australia that requires more of the negotiations pushing the brand pushing the product at the trade level so I think on this one we were pretty strong. I mean that there was some price moves at the bottom of the market very recently I mean at beginning of this year we know that the excise goes up the second -- sorry the scheduled excise increases in the March -- beginning of March, March 1. I mean that the prices ahead of that excise increase start moving up, it’s always been move in the right direction. So I think the worse for us -- I assume the worse for us is Australia is behind us and the things will come to some normality.

We’ll go to Ann right behind you.

I have two questions on your latest conference call I think you talked about expectations for the global industry volumes to return to more historic declines rate of 1% to 2%. What should I think about risk to that number that could throw it off -- to make it weaker than expected, what should we watch for the markets any taxation if you don’t mind?

Well I mean in last year the global was 3 point slightly above 3% and I think it should improve this year 2015, but you have to adjust going to composition of what is global and if you have the Russia more or less going into direction of 9% to 10% that’s an estimate today I mean Russia by size already will keep that global volumes around 3% peripheral. I think the global will be below 3%, will it go to the 1% to 2% which we predict is more of the mix of the long-term trend maybe this is not the 50. But we should see the improvements there I mean even if I take into consideration the Russian estimate for a time being we’ll have better volumes in EU, Indonesia so far I mean and I think there’s a slowing down in the trend. You have a number of geographies when the volumes are growing 30. So all-in-all I think it will be better than the last year but I don’t think it’s going to come closer to 1% to 2% which we have in our mid to long-term.

Costs can you -- I think overall cost for 2015 should I can on that 3% to 5% increase range or can you help me think about cost increases?

No, we said that for 2015 our total cost ex-RRP and ex-currency obviously should not go up, should not increase more than 1%. We’re very confident it is one. Look we have the number of the productivity initiatives from the last year which I’m rolling out in terms of a benefit in 2015 I mean [indiscernible], Australia the fact was closure. I think we feel very comfortable the way we managing now the lift prices and the close prices, so this is sort of inflationary pressure on that component, I should be expecting negatives here and I think going to ‘16 to ’17, broadly the cost should be in the range of 1% to 3% increases. I mean we have a number of productivity initiatives in the pipeline than we can hold the cost increases for this level.

We will leave the presentation and thank you very much again for your participation here and we’ll have breakout session for more Q&A. Thank you.