Philip Morris International Inc. (PM) Management Presents at Barclays Global Consumer Staples Conference (Transcript)

Philip Morris International Inc. (NYSE:PM) Barclays Global Consumer Staples Conference September 10, 2020 2:40 PM ET

Company Participants

Emmanuel Babeau – Chief Financial Officer

Conference Call Participants

Gaurav Jain – Barclays

Gaurav Jain

Good afternoon, everyone. We’re coming to the end of our Staples Conference. I’m Gaurav Jain, Barclays’ Global tobacco Analyst. I’m thrilled to have Emmanuel Babeau, the CFO of Philip Morris here with us. Thank you for giving us the opportunity Emmanuel.

As you might have seen, Philip Morris raised the mid-point of its FY 2020 EPS guidance earlier today, so we will have a few comments from Emmanuel, before I get into my questions.

Emmanuel Babeau

Hi, Gaurav, thank you so much for hosting us and good afternoon, good morning, everybody. Very pleased to be with you to share the latest update on Philip Morris International.

So, I’m going to find with a few elements on what we’ve been seeing over the summer and the month of July and August. And of course, the first element, I want to comment is the fact that we have been revising and narrowing upward our EPS guidance range. We are now targeting a bracket between $5 and $5.07 per share for the adjusted EPS for the year. Remember, the guidance was previously with a range of $4.92 to $5.07. This range would represent a growth of approximately 3.5% to 5% versus 2019 at the same scope and same ForEx basis on an organic basis.

And if we look at the reason for driving this improvement, it’s basically because we are now expecting a Q3 that is going to be better than what we thought when we communicated the last time at the end of July. Indeed, we are now expecting for Q3, a reported diluted earnings per share to be broadly in line, excluding currency with $1.43, which was the adjusted EPS for the third quarter of 2019. As we expect, a negative impact of the currency of about $0.07 that would mean, an adjusted EPS broadly in line with $1.36 for this third quarter.

The reason for this revision upward of our expectation for Q3 is the fact that in July and August, we’ve seen the confirmation of the positive trend observed already in June of a gradual improvement of the trends after the difficult months of April and May. And we even have seen some market performing better than what we thought only a few weeks ago, that certainly has been the case in a few western European market, but that also has been the case in other markets such as the Philippines or Turkey.

We also see a positive evolution of the outlook for pricing in Japan. I will be, of course, happy to elaborate on that in our discussion maybe later on and that’s going to help our performance in Q3, but also in Q4. We also expect some timing benefit, which are going to be inventory related in Q3, but this will be reversed in Q4. So that’s going to be temporary.

It’s quite obvious that this improvement are being achieved in an environment that remains full of uncertainty, and we see day-after-day, I would say, the evolution of the news on the pandemic. I would say, one thing is sure about the difficulty that we’re going to face is that two markets are going to be difficult until the end of the year. The first one is Indonesia, where we see the country still facing difficulties.

And I think a new type of lockdown was announced in Jakarta, only yesterday. So the market is still facing some tough situation linked to the COVID. That is going probably to delay even further, the implementation of a minimum retail selling price. And that’s probably going to mean a tough situation in Indonesia, until the end of the year.

The other market that is going to remain a difficult is duty-free. There was some hope for a beginning of a recovery towards Q4. I think with the pandemic rebounding in a number of countries, we see limitation to the travel emerging again. And that certainly will mean that, duty-free is going to stay very depressed until the end of the year.

We have been continuing our nice growth in our reduced risk product, in July and August. We see continuation of the improvement on the acquisition pace, for new IQOS user. I can report that for the July-August period, we’ve been in 2020. We’ve been acquiring more new IQOS users than in the same period for 2019. And even now when we look on a year-to-date basis at the end of August, we have been acquiring more new IQOS user at the end of August 2020 than what we have been delivering for the first eight months, in 2019.

We also continue to innovate. You have seen that we have launched IQOS VEEV, vaping made right in New Zealand, where we are of course testing the product and also testing edge control, which is absolutely crucial for us, edge verification. And we have a very nice plan for rollout of IQOS VEEV in the coming months in other country towards Q4.

We also have been launching a new reference for our heat-not-burn offering, coming from our agreement with the KT&G. This is a little brand. And a little solid reference has been launched in Russia and not later than today in Ukraine. So we’re going to have now a nice plan for rollout of this new offering, on heat-not-burn product.

And last element I want to share with you. We’ve also announced yesterday a dividend increase of 2.6%, to move to an annualized rate of for $4.80 per share. And quite obviously in this challenging environment, this increase in the dividend is the side of our confidence of the continuation of our successful rolling in RRP in the future.

I think with that I have shared all the information that I wanted to share at that stage. And Gaurav, I’m really happy to answer your question now.

Question-and-Answer Session

Q – Gaurav Jain

Well, thank you for those detailed comments. So I will run into the questions, beginning with your guidance update. So you are highlighting better volumes in EU, which I would say was somewhat expected, but you are also highlighting better volumes in Turkey and Philippines. So do you think that this might be the beginning of a more, broader turn up in emerging markets? And are you seeing a divergence happening in Asian emerging markets and LATAM emerging markets, because those weren’t highlighted?

Emmanuel Babeau

Yes, Gaurav. So we have seen a number of an emerging market or I prefer to call them, new economies showing signs of improvement. It certainly doesn’t mean that we are back to the normal and previous situation, but showing signs of improvement. I would say that the trend today is not really by region. I think it’s largely driven on a country-by-country basis depending on the economic situation and the measure that are going to be implemented.

So, Philippines is an example of a country that has been showing some improvement, Turkey as well. It is true that if you look at Latin America, for instance, Argentina is still a difficult market with a lot of impact linked to the pandemic. But at the same time, we cannot say that the whole Asia is improving, as we see the difficulty on Indonesia.

So I would really say, it’s more on a market-by-market approach that we can identify, where are the places, where we are seeing some nice improvements, and where are the places where difficulty remain at a very high level.

Gaurav Jain

Okay. Now another reason for your guidance upgrade is Japanese pricing. Japan is clearly a very key market for you. We think that it’s almost a 14% EBIT exposure for you. Now the next two years will be very unusual in Japan, because we will have two consecutive excise tax hikes. One will happen in October 2020 and next one in October 2021. And we are seeing that both Mevius and Marlboro have raised prices by 10% this year.

2021 will also see the closure of the tax arbitrage in cigarillos, which has been impacting you negatively. So is it fair to say that between now and 2022, Japan would be a very major tailwind for you?

Emmanuel Babeau

I mean, we certainly expect to see Japan as a positive market for us in the future. Of course, there will be impact coming from this sequence price increase between October 2020 and October 2021. Linked with that there is a number of evolution on price that are going to be favorable and I alluded to the fact that it’s going to help already our Q3 and Q4. But fundamentally, the reason why we expect Japan to be a very nice tailwind is because we are being very successful in this country with our IQOS offering.

And therefore, because we are successful we are gaining shares. That’s a market that we have started to segment with two consumable offering with Marlboro, heat-not-burn Sticks and also HEETS and this very nice differentiating the price positioning allow us to really cover very well the market.

We’ll come with more innovation in the future in Japan for sure. So we are in good shape in Japan. We are progressing well. And you’re right, it’s an important market, and it’s good to be in good shape in an important market for us. So definitely, we expect Japan to be a nice tailwind for us in the future.

Gaurav Jain

Okay. Now coming to Indonesia. So it has been a difficult market throughout this year and you have pushed out the quarters when the minimum retail selling price will be implemented consecutively. So how should we think about it now for this year and also maybe next year?

Emmanuel Babeau

Yes. So Indonesia remains clearly a headwind for us. I think, I’ve been commenting in great detail the various level of difficulties, all the price increase that we had taken in the past and the fact that we were already with a very significant price premium. The fact that there was a new increase in excise duty at the beginning of the year, which was extremely important that the minimum retail selling price not being enforced, meant that the gap was really important.

Then I alluded to the fact that also the pandemic has been eating us largely in large city like Jakarta, where we have overrepresentation in terms of market share. And last but not least, the development of this Tier 2 system, which is a kind of tax loophole if you want, where some local players are developing and that is creating what is not the level playing thing for all the players.

I think the minimum retail selling price is eventually going to be implemented. So I said it, it’s probably going to be only late in Q4. So difficult to see that really helping us this year, but hopefully, it’s going to be more positive for next year. We also mentioned that we were, with our portfolio, coming with a lot of commercial activity and proposal for the consumer to adapt to the origin of the need.

And then, last but not least, we also expect the authorities to really take action to close this loophole, which is very damaging for the country, because it is creating a gap in the excise duty that the country is collecting. We’ll see what are the decision towards the end of the year, but we are certainly hopeful that, because it makes sense for the country, that will be the decision made in 2021. So, we are expecting situation, for this reason, to increase in 2021, but it’s too early to say exactly by which kind of magnitude, because we need to see the answer on this various elements that I’ve mentioned.

Gaurav Jain

Sure. And could you just remind us, if there is an excise hike planned in Indonesia because of this delay that might also get pushed out in 2021?

Emmanuel Babeau

Well, I’m not sure that there is a final position and decision today on what’s going to happen in 2021. You’re absolutely right. So, it will need to be confirmed. I think like in many countries, the decision and the discussion will take place in the coming months. That’s budget time now between now and year-end.

Gaurav Jain

Sure. Now, coming to IQOS, so you have a guidance of 90 million to 100 million sticks for FY 2021. And then there is also this aspirational number of 250 billion sticks by 2025, which has been published in your sustainability report.

Emmanuel Babeau

Absolutely.

Gaurav Jain

Mentioned by Philip Morris quite often. So, how are you tracking versus your guidance and your aspiration?

Emmanuel Babeau

We repeated when we communicate about our Q2. And, of course, based on what I’ve just been sharing with you, can imagine that I’m going to do it again; we are on track to be next year between 90 billion and 100 billion of stick for heat-not-burn. And we are happy with the way we are progressing despite the COVID on IQOS and heat-not-burn. This is a guidance, and we believe that we are well on track to deliver on that guidance. And this is, of course, one milestone. It’s an important milestone, but it’s one step in the continuation of what we expect to be a very strong growth in the future.

The $250 billion is an aspiration, which is not just on heat-not-burn, but it’s globally on the RRP offering that we are going to develop. And it’s, I would say mentioned or quoted in equivalent if you want to stick, but that does include, as well, vaping, for instance. And of course, that means that we will need to be very efficient and successful in developing heat-not-burn, all other RRPs in the next five years.

But, I think, I’ve been alluding to the launch of IQOS VEEV in New Zealand. You will see a lot of innovation coming in the coming quarters for PMI. And I think we have the momentum, we have the understanding of the market and we have the plan to go in the direction of this aspiration. And of course, we’ll keep you posted on how we are heading towards this aspiration.

Gaurav Jain

Okay. Thank you. Now, IQOS did receive an MRTP, a couple of months back, which coincided with you joining the company. So, I would like to — I think, there was some good luck there. Now, we have also seen California has just banned flavored tobacco without having any exemption for MRTP products. So, what exactly does it change on the ground?

Emmanuel Babeau

I’m going to repeat again that really this MRTP authorization is an absolute landmark. So, it’s not the kind of final point and there won’t be no more I would say exchange and discussion with government authorities in states and with regulatory bodies. But I think it shows that it’s time to move to something else. Let’s stop the discussion. Yes, heat-not-burn, IQOS is a different product. It’s a better product. And let’s no longer put emotion, but rather speak about the topic based on scientific evidence and on science-based fact.

And as it is clearly differentiated and better product, the real question now should be, how do we make sure that for the current smoker, you make this product available, understood, and you encourage the switch to this better product.

It’s going to take time. I mean we are not naive. We know that everything is not going to change overnight. And this in California is something that has been of course consider certainly before this MRTP was published.

There will be certainly necessary explanation and war between the FDA and the various states. I think the FDA has a pretty good understanding of what should be done to avoid unintended use and what this new offering can do in terms of flavor. And they’ve been really clearly taking position on that.

Let’s do that by taking the time for discussion and gradually things will happen. We are not starting from a blank page. As you know Gaurav, five states have already said that they would implement a lower taxation of heat-not-burn versus conventional combustible cigarette. So, it’s not as if nothing was happening. Things are happening, but of course, more work and more discussion are needed, but we’re going to go in the right direction.

Gaurav Jain

Okay. Now, just sticking to the U.S. market here, so Altria has communicated its plans to expand IQOS from three markets today to seven markets over 18 months, which isn’t really ambitious in our view. What is preventing the partnership from accelerating IQOS growth in the U.S.? And do you think you need to control the partnership?

Emmanuel Babeau

Again I think that we need to organize the ramp-up in line with the sequence of events. So, MRTP was a very important moment for us and certainly for Altria as well no doubt. We are as you know still waiting for a PMTA for IQOS 3. And it will be important to have IQOS 3 available for the consumer in the U.S. We’re going to keep working with Altria on the rollout of the plan. But we need to do that gradually and as we put the plan together, we have no doubt on the fact that Altria shared with us the great potential of IQOS in the U.S.

We have a very clear agreement in place which is governing our relationship in our partnership agreement, which is based on the licensing. They are in charge of marketing and commercialization. We will help them, but we need to build things in order and as the events are happening. So, that’s an ongoing thing and we’re going to keep working with them.

Gaurav Jain

Sure. Now just looking at the Q2, 2020 results, I think, the surprising thing was that IQOS volumes remained very strong. And they did suggest that the cost of acquiring of IQOS consumers has reduced and that coincided with the switch to digital channels. This is a trend we are seeing across all companies. So this leads to two questions. Number one is that, have those trends continued into Q3? And question two is that does it imply that IQOS growth rate can be higher than was possible pre-COVID with the same marketing spend?

Emmanuel Babeau

Yes, Gaurav. So I think we like many sectors, I would say, the COVID crisis has probably not been creating new trends it has been accelerating a number of pre-existing trends. So we had already in our plan to become much more digital on our commercial engine for IQOS in order to be more efficient in terms of cost in order to scale up more easily that was already planned.

I think what we’ve been doing with the crisis is to accelerate the plan with some cost benefit for the year and we’re going to enjoy cost benefits attached to this acceleration towards digital in 2020. Yes, this ramp-up on the digital expertise and digital strengths for IQOS in terms of commercial organization continue to ramp-up and I expect that to be the case in Q3 as well.

It means that we have a right model to grow IQOS that we have the confirmation that we have right commercial model that we are progressively installing and evolving to make it more scalable and with a bigger reach. I think that was part of the plan. I’m not sure that means that we are going to accelerate the acquisition rate of smoker transitioning to IQOS. It means that it is fully validating what is already an ambitious and nice trajectory.

So I think we have the confirmation that the model works that we are moving towards a more efficient model in term of cost and in terms of scalability that will be beneficial for the company because it means that as we continue to grow on IQOS we’re going to do it in an increasingly, I would say profitable manner. I’m not sure that it means that we’re going to grow faster in terms of acquiring new users.

Gaurav Jain

Okay. That’s very helpful. Now we have been tracking IQOS price premium or discount to Marlboro every quarter. And what we have noticed is that IQOS discount is widening to Malboro at the range of 3% to 4% per annum. And I think based on your recent price moves in Japan, this is now happening there as well because IQOS — the Marlboro HeatSticks is I think now at a 4% discount to Marlboro. What has been the cross price elasticity benefit to IQOS? And if we project it out over a few years do you think that benefit keeps on compounding over time?

Emmanuel Babeau

Very good question, Gaurav. The reality is that first of all, IQOS and IQOS consumables are a premium product, okay? And I mean we may discuss what is a price gap versus Marlboro combustible cigarettes, but it can be sometime at the same level sometimes with some differential. But at the end of the day, it is a premium product without any kind of doubt. So that’s the first element that is very important to have in mind.

The second element that is important to have in mind is that, we can say that price is probably not the reason why smokers are switching to IQOS. You have many, many other very good reason and much more important for people switching to IQOS than the price. They understand the value for them in this new offering, the superior experience for them and they are ready to pay a premium price for that. But I’m not sure that the price itself is the most important driver for convincing them to switch.

Now, on the reason for some price differential with Marlboro on cigarettes, I think, you have to take into account the fact that you also have a different excise duty in many countries. And that precisely to show that people want to encourage when the governments are taking this kind of decision. Very often they believe it’s a nice way to encourage people to switch from combustible cigarettes to IQOS and globally to the heat-not-burn category. So it also justified in several countries some differences in price.

Do we have nevertheless, having said all that, some capacity to increase price in a few countries, because there is this sort of differential? Yes, probably. But once again, I think, here the priority is really to drive this expense that is different and that will convince the smoker to switch to IQOS and we keep this price positioning, which is a premium one anyway.

Gaurav Jain

Okay. Thank you. Now coming to the KT&G heat-not-burn product, which you launched in Russia, and now in Ukraine as well. Can you please talk a bit more about your plans? And would it be possible to share the price point of Lil? And how are you segmenting the market between Lil and IQOS?

Emmanuel Babeau

Sure, Gaurav, happy to do that. Well, the strategic intent is clear. We are the champion of reduced risk product and we champion, of course, first, but not only, the heat-not-burn category. We have an amazing and totally differentiated offer with our IQOS product. With this Lil offering, we are coming with a simple, nice, good value for the consumer product. And if you want, we are segmenting the market in markets that are becoming a bit more mature on understanding the heat-not-burn category. So that’s a role of Lil and Lil certainly that we have been launching in Russia and Ukraine now.

Just to give an idea of the price positioning for the device, it’s going to be around in Russia, let’s say, 15% below the price of IQOS 2.4. Probably close to 50% below the price of IQOS 3. So it’s a cheaper price positioning for what is a different global customer experience. And for the consumable, you’re going to find as well about 15% gap between the positioning of our consumable for IQOS. This is kind of difference. But again, here, we see globally the heat-not-burn category growing. It’s time to segment and propose different type of offering. I mean all of them keep, of course, a premium positioning in terms of a price. But I think the consumer will want to have different choices in terms of experience and some difference in terms of price positioning as well.

Gaurav Jain

And in the $90 million to $100 million guidance for IQOS, does that include lil sticks or that is a separate?

Emmanuel Babeau

No, I think it does include that. I think the guidance was on globally heat-not-burn consumable. I’m not sure that any way that next year, we’re going to talk about huge volume on impact, nevertheless we have some nice ambition to develop the brand…

Gaurav Jain

Sure. Now, how has COVID-19 impacted your plans per share buybacks? And how are you thinking between share buybacks and dividends going forward?

Emmanuel Babeau

Well, as you know we have a very strong commitment behind our dividend. And we’ve been announcing yesterday, just suffice I guess to confirm it. As you know, we don’t have anything against buyback. It can be a nice tactical tool to shape the balance sheet nicely. What we’ve repeatedly been saying is that, we don’t intend to put our rating at risk for doing a buyback. And I don’t think that today, we have the leeway to launch a buyback program. The day, where we’ve been further deleveraging and having a position that can maybe give some headroom for a buyback without putting a rating in danger, we will reconsider that. Again, it’s not a bad tool if you want to shape your balance sheet. Today, we are very focused on the dividend.

Gaurav Jain

Sure. Maybe we will be soon out of time, so just maybe a last couple of questions. So, one question is on ESG. You have been doing a lot of — you put out an integrated report. Are you finding that ESG investors are engaging with you as a mix of revenues changes to more RRPs? I think IQOS is now almost 25%.

Emmanuel Babeau

Well, Gaurav, thank you for asking the question. ESG, at the end of the day is about questioning the company on whether what they are doing is bringing improvement to the society and to the planet and whether their action is being done limiting their impact and according to the best tender that the society and people expect today.

I think we are a very strong contributor to ESG effort of the company. I don’t think that many company can claim that through the product they develop and that they bring to the consumer, they can make a big improvement for public health and the life of people. And we do that by having a very strong improvement of the impact that we have on our planet in terms of every thing we do in terms of consumption, in term of carbon emission. And I will certainly take the time to elaborate on that deeper and deeper in the future.

So we are a great company when it comes to ESG. I think, it’s probably not sufficiently known at the time. So, we can expect us to spend a lot of time with you guys, analysts, because I think it’s important that you understand that as well, but with investors obviously in the future.

Gaurav Jain

Maybe just one last question before we close. On EUTPD, so we will have the next set of EUTPD discussions, which might look at harmonizing IQOS related regulation across Europe. What is it that we should be expecting here?

Emmanuel Babeau

Well, I can tell you that we are expecting certainly an evolution for the good. I mean, the EU is already recognizing that. The reduced risk product should be addressed and look at with some difference versus combustible cigarettes. I think now that the scientific evidence are accumulating that some authorities have been giving their positive view on it. It’s really time back to my earlier comment to move on the question, how do we ensure an environment where we can bring this product in a more efficient manner to the smokers to convince them to switch.

So definitely RP must be regulated because they are not without risk. But they may be regulated in a different manner than a combustible cigarette. And I see two obvious areas where the regulation should be different. One is on the possibility to communicate because if we cannot communicate on the benefit of heat-not-burn, IQOS and all our RRPs product is going to be difficult to convince the smoker to switch.

And I think the other area is on taxation, where the different nature of risk and the lower nature of things that RRPs and IQOS present should deserve a different tax treatment. So these are two areas, where we expect positive evolution in the tobacco product directive hopefully. I think, we expect May 2021 to see a revision of this directive.

Gaurav Jain

Great. Well we are out of time. Thanks a lot Emmanuel for your comment.

Emmanuel Babeau

Thank you, Gaurav for hosting us. That was a real pleasure. Thank you very much.

Gaurav Jain

Thank you.

Emmanuel Babeau

Talk to you soon. Thank you. Bye.

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