Philip Morris International Earnings: HTU Volume and Pricing Continue to Drive Growth in Q3

Philip Morris International PM, or PMI, reported third-quarter results that were in line with our forecasts, supported by strong growth in the recently acquired Swedish Match business, continued strong price increases in cigarettes, and positive portfolio volume growth. The pricing performance, in particular, supports our wide economic moat rating, which remains in place. We also retain our $103 fair value estimate and believe that PMI’s leadership in heated tobacco, demonstrated by the 18% volume growth achieved in the segment in the third quarter, justifies a valuation premium to competitors. The market may be disappointed by management’s lowering of its full-year guidance, but we believe most of the drivers of that change are transitory in nature and do not affect the underlying value of the business.

PMI’s third-quarter year-over-year organic revenue growth of 9.3% was driven by 9% price/mix in the combustible segment, and volume growth of 2.2%. Cigarette volume fell by 0.5%, while heated tobacco units, or HTUs, grew by 18%, with this unit representing 26% of total tobacco volume in the third quarter, up from 13% in the second.

Inflation was apparent in third-quarter costs, as higher costs, including salaries, contributed to a 70-basis-point contraction in the reported operating margin over the third quarter last year, along with negative mix in the cigarette portfolio. While it is disappointing that the company’s strong pricing power could not fully offset inflationary pressure, tobacco companies have generally fared much better than manufacturers in other consumer product categories, and we retain confidence in our forecast of modest margin expansion in the medium term.