Philip Morris International Inc.

Moat: 3/5

Understandability: 2/5

Balance Sheet Health: 4/5

Phillip Morris International is a multinational tobacco and smoke-free products company, renowned for its iconic cigarette brands, and is actively pivoting toward a future of smoke-free products.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Business Overview: A Global Giant Navigating a Changing Landscape

Philip Morris International (PM) operates in a highly regulated and increasingly challenging industry, navigating complex global markets while pushing toward a smoke-free future.

  • Revenue Distribution: PM generates revenue primarily through the sale of cigarettes, heated tobacco products (HTUs), and, to a lesser extent, other nicotine products. While cigarettes remain a significant revenue driver, particularly in regions outside the US, their contribution is steadily declining as the company pivots towards smoke-free alternatives. In the latest quarter ending September 30, 2022, net revenues from combustible products stood at $5,254 million compared to a total net revenue of $8,277 million for PM, showing significant diversification.
  • Geographic Reach: The company has a strong presence in Europe (42% of net revenues in latest 9 months 2023), South & Southeast Asia, Middle East and Africa (33%), Latin America (14%) and East Asia & Australia (10%). Although PM is a U.S. company, it does not sell cigarettes in the U.S.
  • Industry Trends: The tobacco industry is witnessing a significant decline in traditional cigarette consumption, especially in developed markets. This is offset, in part, by growth in lower-risk alternatives like HTUs and vapor products. There is also a huge shift in regulatory approach to tobacco products around the world. A combination of the 3 has caused a slowdown in revenue growth, although more profitable sales are being seen in certain regions.
  • Margins: Operating margins have been relatively high, averaging near 40% in the last three years, although there has been volatility in different regions. These margins reflect the addictive nature of nicotine, which translates into customer loyalty and therefore higher profitability.

Note that both net revenue and operating income are negatively impacted by currency exchange fluctuations, particularly with regard to the USD.

  • Competitive Landscape: In a highly competitive and complex global industry with many tobacco companies, few have true pricing power. The industry is also heavily influenced by regulations and trade agreements which can favor or disfavor companies in different regions.
  • What Makes PM Different: The most distinctive thing about PM is its long-term goal of transitioning into a smoke-free business, while continuing to squeeze profits from its traditional cigarette sales. The company is also quite open to acquisitions, and has been acquiring companies that are in line with their strategy. They also are very active in scientific and communication efforts to prove their new smoke-free products to be better for consumers’ health than cigarettes.

They also seem to be very focused on a few markets where the products are selling very well, and doubling down there, which will also likely lead to increased profits.

Financials In-Depth: Navigating Volatility and Transition

While PM’s core business continues to generate substantial cash flow, its financials show both a large scale and a period of transition.

  • Revenue Growth: Revenue growth in aggregate seems to be driven by price, but the volumes of many products, including cigarettes, heated tobacco and snus have decreased year over year. In the 3 months ended September 30, 2023, net revenue reached 8.9B USD, compared to 8.85B from the same period the year before, a small increase of 0.6%. Looking at 9 months ended in September 30, 2023 total net revenues excluding currency were up by 1.7% while total shipment volume was down 1.4%, indicating that while sales are increasing prices are a big factor.
  • Profitability: Gross profit, however, has been increasing YoY, thanks to higher margins on the main product segments. In the quarter ended September 30, 2023, adjusted gross profit was 6.76B USD, compared to 6.54B USD from the previous year. Reported operating income also rose to $3.83 Billion, 15.6% increase compared to the same period a year before. Net income was $2.47 Billion, a notable 20.1% increase.
  • Cash Flow: The company’s operations remain highly cash-generative. Net cash from operating activities for the first 9 months of 2023 was $8.1 Billion, significantly more than the $6.4 Billion in same period in 2022.
  • Debt & Leverage: While the company maintains a high debt level in order to finance its operations and acquisitions, the leverage is manageable with its high cash flows. Total debt stood at $26.5 billion as of September 2023.

The ongoing economic uncertainty, coupled with geopolitical factors including the war in Ukraine, and the increased inflationary pressure in several markets could present significant headwinds for growth and overall profits.

Moat: 3/5

PM does have a significant moat, stemming primarily from its brand recognition and pricing power. However, the company is in a constant shift, from traditional cigarettes into less known smoke free alternatives.

  • Brand: PM owns very strong and iconic cigarette brands that remain in high demand in many parts of the world.
  • Pricing Power: The addictive nature of nicotine allows PM to pass on costs to their consumers, generating consistently high margins and cash flows.
  • High Switching Costs: For its smoke free segment, the high cost of switching and learning new devices may create a powerful switching cost moat in the long term.
  • Regulatory Approval: There are regulations, especially when it comes to novel products such as heated tobacco that can allow PM to have a monopoly in a specific region, and even in a whole country.
  • Weakening Moat in Cigarettes: The brand advantage may erode, especially given the decline in traditional cigarette smoking. In many areas there may come stronger legislation from governments that may force companies into more price competition.
  • Weakness in Smoke Free Alternative Moats: The cigarette and heated tobacco markets have historically been controlled by few giants, but it is not certain that this situation can be replicated in the smoke free alternatives segments, where there is no market leader yet. Any moat that they build in this segment is probably narrower and more fragile.

Understandability: 2 / 5

PM’s business operations, while conceptually simple, are made extremely difficult by regulations that are present in different geographies and that change very often. This coupled with complex financial reporting creates a challenge for the average investor. The different segments, the impact of acquisitions, different tax structures in all parts of the world, all make the company harder to understand, hence a rating of 2.

Balance Sheet Health: 4 / 5

PM’s balance sheet shows solid financial health, which has allowed the company to continue generating profit while funding acquisitions, while retaining significant cash flows for future needs. Despite a reasonably high leverage, their revenues and profits are stable.