Philip Morris International Inc. (NYSE:PM) Barclays Global Consumer Staples Conference 2024 September 3, 2024 12:45 PM ET
Company Participants
Jacek Olczak – CEO
Conference Call Participants
Gaurav Jain – Barclays
Gaurav Jain
Hi, good afternoon, everyone. I’m Gaurav Jain, Barclays Head of Global Tobacco. With me today, we have Philip Morris’s CEO, Jacek Olczak. Thank you so much for giving us the opportunity for this fireside chat.
Jacek Olczak
Good afternoon.
Gaurav Jain
So PMI stock is currently trading at all-time highs. The last time PMI hit $120 plus was in 2017 and that was a time when IQOS had just launched and was growing rapidly in Japan. Year-to-date, PMI stock is up 35% ahead of S&P — S&P Staples Index, which is up 16%, and S&P and NASDAQ, which are each up about 20%. Now, PMI has been a very difficult stock to own at times over the last 10 years for various reasons, particularly FX and also investments associated with its NGP transition. But despite all of that, today, its 10 year returns are in line with Broader Staples Index.
So now the question for all of us is that can PMI from here on systematically outperform S&P 500? So, Jacek…
Jacek Olczak
This was a question or…
Question-and-Answer Session
Q – Gaurav Jain
This was setting the expectation that I think all of us have. So the first question, just going back into history when PMI split out of Altria in 2008, it used to talk of volume growth and 10% to 12% EPS growth without share repurchases and it was growth driven by emerging markets, and now we are talking about volume growth again, which is driven by high profit pool markets like U.S. and Europe and also driven by NGPs, which have better unit economics. So do you think that we can look back and actually at 10% to 12% EPS growth and even north of that, like, 12% to 14% because growth is now driven by NGPs?
Jacek Olczak
Well, this is actually a good way to start because when I recall — I was at that time CFO, so I recall it very well, almost what was the first growth algorithm for PMI, so you may recall, especially those of you who follow us or not even for a longer period of time. At that time, growth algorithm was 3% to 5% on the top with the flat to slightly declining volumes. Obviously, there was a lot of pricing contribution at that time, translating to 6%, 8%, and high level, and 8%, 10% on EPS, no buyback. Buyback would been able to lift it to 10%, 12% and this is what we were delivering for quite a few years.
I remember the early conversations when we opened the smoke-free category very much kind not bad with (ph) IQOS that what does will — what will it bring to PMI from a growth profile perspective going forward, and at that time, I volunteer that I think we can leave the numbers by the good 2 points of a growth across all of these metrics. So here we are, good few years later, and you could see that the volumes for the last three years, which is very difficult, if almost impossible in a classical tobacco cigarette industry to be at the flat. I mean, we are actually in a growth combined volumes despite the fact that, obviously, there was an underlying trend on a cigarette amplified by the cannibalization to our own heat-not-burn platform, but we can lift it all to the positive territory.
Revenues are growing in mid-single — at the mid-single level with a good quality, again, coming from a volume mix, which enhanced the margins of the unit revenues and the margins. And there is obviously, the pricing — pretty strong pricing, I would argue on the cigarettes, smaller for SFP, for smoke-free products, the categories in the different stages on development. And then we can deliver with the reaffirmed guidance, which we just issued today, 11% to 13%, no buyback, right, so since pretty strong results compared to where we were a good few years ago.
And I think there is still ample room for a growth going forward. I mean, you know very well that for the last almost two years, we’re back to the U.S., we’re on the back of acquisition of Swedish Match with ZYN, which adds very nicely to our profile growth on all metrics. I mean, margins are very attractive, product squarely delivers on the promise of a smoke-free, better alternatives to cigarettes, and there is a growing market essentially in every — almost in every place in the world unless for some unexplainable, stupid type of reasons, the products are banned while cigarettes are being allowed. But other than that, you have a growth in every geography.
So this year, I think will be another confirmation that this transformation was not only very attractive, obviously from a smoker’s consumers’ perspective, but equally very attractive from an investor’s perspective because, I mean at the margins, we’re looking for the margin expansion, importantly for us also in the dollar terms, not just on the adjusted ex-currency basis. We’re looking a very strong — very, very strong Q3 results. Every quarter starts bringing us more and more confidence and to your question, should we expect more? I mean, definitely, there is room for PMI to continue with the current growth, which I would argue is very strong, but we’re also trying to use every opportunity to enhance the gross profit.
Re-entry to U.S. — sorry, it’s a bit long, but the one thing and that’s very much, we all know it, which was behind the sort of, I guess, share price performance always is more difficult as an insider to explain. It is the currency profile of PMI, right, which was the underlying results of PMI on the new products, but also on the cigarettes were extremely strong. And the question was that if the currencies were going against us, it was difficult to lift it — to lift it in the dollar terms, but the thing is we all see it, I mean, the currency is starting to adjust in different directions, positive to us. So I think if we address — we’re also increasing our profile by the presence in the U.S., not maybe in a very substantive manner, but better than we used to have before.
The pricing comes strong, etc., so I believe not only we can — we can deliver a very strong adjusted ex-currency basis growth, but very importantly also the dollar growth. As you know, it’s very important to us from a cash flow perspective, and you know very well our strong commitment to the dividend. So obviously, we’re very much aligned, I guess, with the market expectations.
Gaurav Jain
So just going to the volume growth, which is happening now for you and it is being driven by some of these high NGP penetration countries, so we are seeing market volumes stabilize, particularly in Japan, at least Scandinavia, all regions where NGP penetration has reached 20% plus, so do you think this is the right conclusion that NGPs improved secular volume trends or these are just some aberrations happening?
Jacek Olczak
No, I believe that — okay, all the NGP markets, the smoke-free products markets, right, by category, okay, we obviously very much focused and they occupy a lot of our — quite rightly, a lot of space in our conversations, but these categories are still in the very early phases. I mean, obviously, the youngest one is nicotine pouches that — in the U.S., which obviously is the point of attention of many of us. I mean the category has not even scratched or is scratching a 5% level. So, it’s in the 95% of the market is in a different form than pouches.
Okay, heat-not-burn is more advanced in many geographies, e-vape, but still majority of the product in any geographies in a conventional form. But what we see that each of the products being heat-not-burn, e-vape, and very much product like the nicotine pouches, they offer adult smokers different opportunities compared to the cigarette smoking in terms of the moment of consumption.
And I think that’s the sound underlying factor behind the growth of this category in addition, obviously, to the switching. I mean, it’s pretty obvious that I’m not disclosing the rocket science here that there are more constraints where people would free — be free from a societal pressure perspective or from a regulatory perspective of using a cigarette, but definitely, these pressures are different and attitudes are different if you go to the heat-not-burn, e-vape or the pouches, right? The pouches, which obviously are the most discrete.
So it’s very fair to assume that this will translate into the different consumption patterns going forward compared to the beginning, if we take a cigarette, combustible cigarette is the beginning of the category. So I believe the volume outlook, the way we measure, right, the volume outlook, I think is pretty — my view is very positive. Obviously for the companies like ours, when you take a lot of first-mover advantage and you’re building the brand and you create the category, it’s obviously harder from a perspective that you need to take a lot of effort on your organization, but also the returns are very nicely rewarding you for this first mover sort of a strategy.
But the volumes, I think is a lot of — I think over a period of time, we might be looking at the industry from a completely different volume perspective that we remember this from a combustible — from a combustible product. For the products, we offer is completely different, harm product — harm profile. I mean this products are significantly reducing the exposure as you know all. We know all adds to the harmful compound you find in a cigarette smoke, so there is clearly the benefit compared to continuing smoking. And smokers, users are tingling (ph) more freedom in terms of how I can interact, how I can use the product.
Gaurav Jain
Sure. So on our math, your volumes will be positive even if you start increasing cigarette prices, which historically you have increased at 5% to 7%, if you take that algorithm up to 7% to 9%, that would lead to some great market share loss, but then you will gain share through NGPs, so net-net, you will still be positive on volume share. So the question is that, are you at a point where some of the countries, you can now run on a total nicotine volume share basis, which means that one of your key KPIs, which is flat cigarette market share globally is not met?
Jacek Olczak
Yeah, okay. Let me translate your question, Gaurav. You’re asking, can we do more pricing?
Gaurav Jain
Yes.
Jacek Olczak
So, here is the thing, we do pay attention to market share, I’m talking about combustible part of the business, but not to the extent, obviously that in a category, which we all know — in our view, the destination of this category that we should be too much worried about the market share, but not to the extent just to do the pricing, which will accelerate our declines. Because you have to remember the category offers attractive margins, right, in the consumer space. The second is a very strong cash flow, which is associated with these margins and these cash flows are very important to — for a number of the corporate needs, including, as I mentioned, our commitment to the strong dividends, etc., so that’s the one thing.
Does it mean that we are not really as — in many markets, we are the market leader, then we will don’t shy from taking the pricing in the market. Even if you like, last year or this year, right, what is baked into the guidance, we come in with a very, very strong pricing variance even including in a dollar absolute terms, taking into consideration — sorry, this pricing variance in absolute terms will be higher than the pricing variance we’re turning in the past despite the fact that we saved quite a lot of cigarette volume. So we’re actually delivering much more absolute terms — dollar absolute terms pricing variance than in the past despite the fact that we have less underlying cigarette volumes. So that’s the one thing.
When it comes to the share on the total nicotine space, okay, by the fact that you’re growing in pouches, the fact that you’re growing with the heat-not-burn and also recently with the e-vape, I mean, obviously, our share will go up. So we have to — our ambitions are much higher. But look, the share is — share is very important, but I remember one of my predecessors used to say, I can’t pay the dividend for market share. So you always have to bear in mind what is the value behind that share, and yes, we do focus on maximizing the value of the cigarettes — on our business. Share is secondary type of the measure. We will not abruptly react to the 10 basis points or 20 basis points type of movement, but we will not do the pricing, which will all of a sudden start collapsing our positions in a marketplace.
Gaurav Jain
Now investors think and moving to IQOS that investors think that PMI has been routinely bullish on IQOS, and then had to adjust guidance down, especially on volumes, so do you think a change in approach to IQOS guidance is needed now where you have reached in terms of scale on IQOS and its share in your business?
Jacek Olczak
But then investors will tell us that we are low bowling, so they always go in this back-and-forth type of a conversation. I mean, yes, we had — it happened to us that we had to adjust the outlook for — in a given period for IQOS, but let’s also take it, I mean, the way I look into this is, you’re taking a billion or a couple of billion of adjustments in the final volumes you’re delivering for a period, right, usually there are number of other factors that play rather than something which would — we should be worried about the longer-term.
So yes, I mean, sometimes maybe we should be more precise going forward than a factor number of the moving parts and very well in addition to — every new consumer to IQOS is gained for the new time, right? Nobody — never did a smoke-free transformation before and we cannot be arrogant that we know with all those learning with the first cohort of consumers and the second cohort of consumers, etc.
I remember that we had a few years ago a bit of a slowdown in Japan and everyone reacted very nervously. If you look from today’s perspective, where is Japan, it would essentially consider the — event of the some years ago, just the bleep (ph), which we shouldn’t really react and definitely not overreact to this whole thing. By the way, Japan, and we have said it at the beginning of the year, volumes of heat-not-burn category, obviously very much driven by IQOS.
In Tokyo, crossing a 50% mark, and I think everything indicates that if we continue like this, Japan will be the first market next year, 2025, you will have a more volume of heat-not-burn than the cigarettes. So the progress is there and the growth is there. I think the challenge which we have is we’re not really debating whether there is a growth, it’s more the question of is this growth going like this, so what is the angle of the growth, right?
What is the rate of the growth? And we had the EU situation, right, with the ban on the flavors at the beginning of the year, maybe was not that stronger. There were some pressures in Italy. But if I look at the Q2 or current performance of Italy, it seems that we’re going back where we wanted to be, etc. So some of these factors are difficult to very accurately estimate, if you like, assess and said, okay, this is what it is. And usually also try to come with a guidance, which is not what I call the Swiss pharmacy with the second digit after comma type of the thing, it’s 140. From my perspective, we deliver 139.5 or 141.
To be very frank from a scheme of the things, the same number. I understand the value of another billion, but this is more the question, do we observe a consumer trend changes versus the past? People are trying and adopting the product. Are people happy with my product, with my brand? Do my brand — does my brand equity goes up? Do people keep on referring my product to others? If I score well and over these parameters, by definition, I will grow the volume. How much — I may be under overestimating this whole thing, but this is not I think something which personally I would be very worried about.
Gaurav Jain
Sure. And can you, in that context, just remind us of the impact of the EU flavor ban on IQOS this year and I think the comments that were made on the last call was that 2025 should be better because things should accelerate, so — for IQOS and you, so can you just remind us?
Jacek Olczak
Yeah. So we’re looking — we’re looking at the second half of this year, right, to be stronger than the first in terms of the growth, and since that looks that we going into this direction, so we are fine with this. We have estimated that the — okay, the challenge with the flavor ban in Europe is that it is not the one day or one-week when the ban is being complemented across all the European markets, right?
So different markets have different timing, different sequence, so that’s a little bit that puts the extra pressure, if you like, given on our own estimates. We have estimated at the beginning of the year that the impact in 2024 might be in the range of about $2 billion, presumably, it will be $2 billion point something. I mean, a couple of few hundred more millions.
But the more the question is what do we observe in the markets, which relatively earlier have entered into the or implemented the flavor ban and what is the time they’re returning to the growth comparable so they used to have behold, so we look at the Central Europe, I mentioned Italy, and this is coming back.
So our assumption that flavor ban has some time sort of an impact or temporary type of an impact, it is difficult now to say how long is temporary, but seems that is supported by what we observe in the marketplace. So you go through this distortion. And I’m not just talking consumer demand because there is demand, which is — sorry, demand meaning consumption, but this demand, these people know — consumers know that the product will be banned. They’re buying more.
Trade is taking different actions. So it’s a lot of — some level, not a lot, by some level of distortions in the marketplace. But I mentioned, Italy seems that they are regaining the momentum from the past, that’s okay. Central Europe, I mean, Czech, etc., a few other markets were going through this whole exercise of that situation, seems that they are on a good path.
There’s the different rate of the growth in a different market, but there is a growth and it goes in the right direction. From the large markets when there is still a relatively high proportion of the flavor product would be Poland, the sizable market, but Poland, I don’t think they’re going to implement anything this year, at the earliest presumably the end of the year, but not nothing now. So this will be more a 2025 — next year event.
Gaurav Jain
Sure. Now quickly moving to ZYN, where the success in the U.S. has been clearly phenomenal, but currently, you are constrained on capacity. Now you are expanding capacity, you’ve given us some numbers, at least on gross CapEx at your prior call. So you have lost some share, and the question is, as your capacity expansion happens, how confident are you that you will gain back the market share?
Jacek Olczak
Well, we must have some level of confidence, otherwise, we wouldn’t announce in the span of four weeks to capacity expansion plans, so it means we would make a mistake somewhere else. Colorado, which we announced first, Aurora in Colorado is more or less the greenfields, which will come in a two years’ time into the chain — into the supply chain. But we also obviously address Owensboro and max out what we — Owensboro is the existing — Kentucky existing current Swedish Match operations, right, the only manufacturer in the U.S. of a ZYN product. So we max out — we’re now maxing out what we could do with Owensboro, that’s the $900 million next year. So this year, what is our guidance on the volumes, okay, $900 million capacity, obviously for next year assumes the growth and I believe that growth is there.
Now we have lost Swedish Match because ZYN has lost a few — a couple of few percentage points on the market share, but it’s very interesting, especially if you follow Nielsen or other market statistics is that since — this is unfortunate out of stock situation with ZYN, the entire category growth has stopped. It has lost the dynamics which it had before, which tells me that this was a ZYN who was actually — which was driving the category, not just any other products in the marketplace. So there is a bit of a shaving of the — loss of the share going to some of the competitor’s brand, but this is in a range of a few percentage points, okay, 4 percentage points, 5 percentage points, presumably not even.
But the category has stagnated, now ups in the ZYN continues and unconstrained supply. We will unfortunately be with the situation because before we get to this $900 million capacity next year, I mean, this will not happen as of January 1. There was a time to get there, but I think — sorry, I wanted to say that the $900 million — how to phrase it properly that they manage their expectations that the growth might be obviously beyond the $900 million, and if that happens and faster than we think, then we may be in the constrained situation beyond Owensboro expansion. This is what I wanted to say.
As is the Colorado expansion, but from a timing perspective, we don’t know how it’s going to last, okay? So, I am more comfortable that we’ll get it. Now the question is how quickly we can put the entire category because it seems that the ZYN was the carrier of the — of generating the growth for the full CapEx.
Gaurav Jain
So with such strong growth in ZYN, then I guess the concern that investors have is, youth uptake, and there is a lot of conflicting data points which are floating around and we will have the FDA’s youth tobacco survey out probably in the next month or so. But even beyond this youth tobacco survey that, let’s say, even if there is like low prevalence in this survey, what are you doing to actively prevent youth uptake?
Jacek Olczak
Yeah. So look, the whole conversation is about the youth access to the product, youth access to the exposure to the marketing, communication about the product and something which from the very beginning and all of us, I’m talking PMI, we’re taking very seriously, right? I mean, how we — everyone knows how we execute the [indiscernible] market — type of issue whatsoever, and FDA and the others obviously know — I mean, it’s all transparent, etc.
ZYN obviously creates a lot of unnecessary excitement, very much driven by our social media. I think what we’re doing on the physical access to the product, I feel very strong about this and being the assistance of the retail networks — the retail shops, etc, so access — physical access to the product, it’s actually very doable to have a strong grip on. Obviously, you always may find one or two independent general type of retailers, but you can send the salesforce, delete their account, and you have quite a lot of imports or pressure points on that thing.
Controlling the access to information, especially with the prevalence of the social media, etc., on the user-generated content is becoming more difficult. So even if a PMI and a Swedish Match have a very strict policy, not influencers, or age limit for the model, if you use in advertising, etc., and these are very well-known documented, etc., practices which we have. The one thing which is difficult for us to control is what is — what exactly are the conversations in the social media, not triggered by us, not triggered by the brand, but just triggered by the users.
We reaching out to social media companies for their help. I think there is the room for some moderation, etc. Some of this conversation depends on the followership that some people have, should be a little — should be more restricted just not to expose, not to the product, but to the information about the product. So I think the practices which Swedish had before, obviously now is the part of the Philip Morris Group, etc, I feel very confident and these are the things which are known to — important to stakeholders.
But obviously, it’s a public perception and we all have to be very careful, on the nicotine containing products, etc., etc., and these products are not for the under-aged people, and they were not designed for them, and the audience are the adult smokers, this is what we should focus. So I think we have the things under control. Obviously, absolute zero doesn’t exist because you always will find the one retailer or whoever — who will be non-compliance, but you have a pretty good path to control it.
And other things, which we’re doing is also protecting the market from access of products which are not authorized by FDA. So you all know it, Swedish ZYN has the pending PMTAs, and by the way, in Q2 of this year, we filed MRTPA for ZYN product as well. So on the regulatory side, we’re obviously awaiting FDA decision, but we’re also protecting the market from a diversion of the product in the formats which were not — which are not subject by even the pending PMTAs from outside, which also demonstrates how responsible we are in controlling the — in controlling the market.
You’ve heard, we shut down pretty fast zyn.com, the Internet sites supporting the e-commerce sales as the reaction of some situations in DC. So I think we’re always — it’s not that we demonstrate, but this is what we’re doing if we see that something is going out of the hand, I mean that our company can act very swiftly and we have the full force to address the problem.
Gaurav Jain
Sure. Now coming back to the comment around share repurchases that we are making earlier, so you’re clearly well north of your 2x leverage target, and the comment that has been made at times is that you will start buying back shares when you will have a line to sight to 2x leverage, so is it that, let’s say, you’re level at 2.3x, but you see yourself going to below 2x next year, you will start share repurchases or you will actually wait till it goes to like 1.8x and that will…
Jacek Olczak
Yeah. So there’s always, as everyone knows, it’s always up to the Board, right, to authorize or not the share repurchase. But I think we are on the good path post the acquisition of Swedish Match on leveraging. And I think the outlook, which we have said that we should be in about two-ish type of a territory somewhere in ’26, especially even if I take this year that we are reaffirming that, okay, strong growth, but also expansion in margins in the dollar terms, etc. So I believe we are on a good path to be in the 2-ish type of a territory in ’26. And then it’s the moment — so somewhere the visibility of this whole thing you will have in ’25 and I think this is the period which will start to considering.
Remember, this is pretty obvious what they’re going to say, but share buyback for us was also — was always absent other uses of capital. Obviously, dividend for us is very important. We have demonstrated even in a little bit under pressure, especially from a dollar perspective that we will focus on dividend and go with the dividend above what the dollar earnings would indicate. I think we curise it or drove it to the right territories now. So dividend for us is very important. Share buyback, as I said, is the Board and absent and then other uses of the cash just formality — formality perspective.
Gaurav Jain
Sure. Okay. Now one of the criticisms against PMI historically was that the dollar EPS didn’t really grow, and now because of the growth in your U.S. business driven by ZYN Zen, you can certainly — I guess you can still have some ranges around FX, but you can definitely think about a minimum dollar EPS growth or some sort of, communication to the market that you can actually grow a dollar EPS number at this number despite whatever could happen in FX. So is that something that you might think of that, let’s say, minimum dollar EPS growth of 5%?
Jacek Olczak
Yeah. I mean, we have quite a few KPIs, right, for which the company is measured, assessed and including me and my executive team, etc. So we obviously have a cash flow — if you have a dollar-type of measures and you have a few other measures, I don’t think we would go into the direction of changing. I believe it serve us pretty well through this whole period with the focus. Obviously, we have said that by the fact that we committed so much to the rewarding shareholders, primarily through the means of a dividend, and obviously, it’s not just the dividend and its growth, etc., then obviously you go straight to the cash flow and dividend is in the dollar, so your cash flow in the dollars have to cover all our needs and obviously for the dividend distribution. So somehow, if you like directly or indirectly, the dollar focus is there.
But having said so — we said — I said it a number of occasions that, yes, there is a good environment from the pricing, right? We started with the pricing because of the excise type of environment, you don’t have abrupt and disproportional type of excise increases, so this obviously is the good block on which you could build the pricing strategy. It works with — that obviously helps a lot also from a dollar — in a dollar terms of the revenue and the margins, what we’re bringing home. But pricing, making a domestic market pricing decision based on the currency — the currency exchange rate may also be a very bad idea, right?
So, if you take a yen, historically, now yen goes our direction, so there’s a lot of strengthening. But consumers are spending money in the local currency, okay? So if you exaggerate with the pricing driven by the exchange rates, you will end up with a pricing in a market, which completely doesn’t fit into what is the disposable versus the power of the purchasing power in the market. So we need to balance this whole thing, which doesn’t mean that you can still not optimize a search and look for the value to achieve the ultimate objective, which is keep on moving our performance measures, our performance numbers in a dollar terms.
Gaurav Jain
And with that, we are out of time. We have a breakout as well. Thank you, so much, Jacek, for the time.
Jacek Olczak
Thank you.
Gaurav Jain
The breakout is right around the corner, so see you all there. Thank you.
Jacek Olczak
Thank you.
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