Philip Morris International Earnings: Disappointing Guidance Overshadows Future Benefits of Iluma

Philip Morris International PM reported first-quarter results that were in line with our expectations, but management guided to slightly weaker full-year earnings growth than we had forecast. While this may be disappointing to investors, the spending behind the rollout of Iluma, Philip Morris’ latest iteration of its Iqos heated tobacco platform, and the associated impact on its margin should drive medium-term growth, allowing Philip Morris to compound its high returns on capital, which have historically been in excess of 30%, for years to come. Therefore, we are maintaining our $103 fair value estimate and wide moat rating, and regard the stock as being slightly undervalued at the close of trading on April 21.

The first-quarter cigarette shipment volume decreased by 3.1% year over year, while the heated tobacco unit volume increased by 10.4%. Adjusted revenue grew 3.2%, despite a strong first quarter last year. This represented a slightly weaker shift from cigarettes to heated tobacco than we had anticipated, but we expect the migration to reaccelerate later in the year as Iluma is rolled out in more markets. Price/mix in excess of 7% was slightly below our expectations, but consistent with historical trends, and if consumers rein in spending this year, raising prices could become more difficult as the year progresses.

The first-quarter consolidated operating margin of 43.6% was a whisker above our estimate. The margin fell by almost 6 percentage points over the same period a year ago, primarily due to increased investments around Iluma. While we expect margins to recover as these investments yield returns later in the year, we expect margins to gradually erode over time and forecast a 41% steady-state margin.