Philip Morris International Earnings: Combustibles Perform Strongly

Philip Morris International PM, or PMI, reported second-quarter results that were modestly above our expectations, due to robust volume in the core combustible segment. On top of low-double-digit organic net revenue growth, subsidiary Swedish Match made a significant contribution to reported year-over-year revenue growth of 1.5%. We are retaining our $103 fair value estimate and wide moat rating. PMI is trading close to this valuation, and we believe a more attractive risk/return profile exists in some of the slightly-lower-quality tobacco companies such as Imperial Brands and British American Tobacco, but these results again confirm that PMI’s valuation premium to peers is justified, and PMI may prove to be more defensive than most in the event of global macroeconomic deterioration.

PMI’s second-quarter organic revenue growth of 10.5% was driven by a 9% pricing increase and 26.6% growth in heated tobacco unit volume, with this unit now representing 13% of total tobacco volume. This was supported by a lower-than-expected combustible volume decline of just 0.4%. Management believes industry volume in its footprint declined by 2.1% in the second quarter, implying some share gains, but the company’s volume decline may reaccelerate later in the year. Nevertheless, this was a respectable quarter, given the rising pressure on consumers in most markets.

Swedish Match made a strong start under the ownership of PMI, and the acquisition was accretive to reported growth. On a pro forma basis, oral product shipment volume (primarily Swedish Match’s Zyn brand) increased 13.8%, most likely boosted by greater distribution on the PMI platform, but also indicative of the ongoing growth of the category. In our opinion, PMI has the strongest portfolio of noncigarette brands, with Zyn in oral tobacco and Iqos in heated tobacco, and this should help it manage the impact of volume decline in cigarettes.