PMI: Not All Roses

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Sell-side analysts believe that Philip Morris International (PMI)’s healthy business fundamentals and encouraging growth outlook aren’t yet reflected in the share price. The average analyst target for PMI is around $114 – implying a 20% upside. Although the sell-side is pretty convinced, PMI share price struggles to break out to the upside. The buy-side is not convinced. We understand and share the buy-side’s reluctance. It is Not All Roses for PMI!

Post-publishing note: We cover only three buy-side concerns in this article and discuss the first two in details. For a complete list of points on which PMI needs to convince the buy-side, please refer to the “PMI – 2023 Investor Day: Preview” write-up.

(1) Regular one-off items & negative currency adjustments

(2) Unconvincing Healthcare endeavors

(3) Upcoming EU TPD & TTD revisions (- Our assessment on this topic is privileged & confidential. See our proprietary research report).

(1) Reported vs. Adjusted EPS

PMI reported $5.26 EPS in 2013. For 2023, PMI guides $5.36-5.45 reported diluted EPS. In 10 years, PMI’s reported EPS went nowhere. During this time, PMI’s lowest reported EPS was $3.88 in 2017 and highest reported EPS was $5.83 in 2021.

20132014201520162017201820192020202120222023E
Reported EPS$5.26$4.76$4.42$4.48$3.88$5.08$4.61$5.16$5.83$5.81$5.41
Growth-10%-7%+1%13%+31%-9%+12%+13%0%-7%
Adjustments$0.14$0.26$0.84$0.02$0.58$0.01$0.25$0.17$0.77
Adj. EPS$5.40$5.02$4.42$4.48$4.72$5.10$5.19$5.17$6.08$5.98$6.18
Currency$0.80$1.20$0.46$0.21$0.11$0.13$0.32-$0.12$0.77$0.33
Fully Adj. EPS$5.40$5.82$5.62$4.94$4.93$5.21$5.32$5.49$5.96$6.75$6.51
Growth8%12%12%10%10%4%6%15%11%9%

PMI’s adjusted EPS (i.e. adjusted for one-off items & currency variations), on the other hand, has grown 9.6% per year on average in this period. Magical! 2023 is of no exception: PMI will report -7% reported EPS decline and +9% adjusted EPS growth this year.

In the 2013-2023 period, PMI has made $0.28/share one-off item adjustment and $0.38/share FX adjustment per year on average – adding up to $0.66/share adjustment every year. This corresponds to ~10% of adjustment if we take the 2023 adjusted diluted EPS ($6.46-$6.55) guidance as a base.

One-off items (mainly asset impairment & exit costs, litigation-related expenses and tax charges) are inherent/natural to PMI’s line of business: we cannot know these exact adjustments for the years to come, but we are fairly certain that these adjustments will run forever.

Moreover, PMI reports in US$ although it makes less than 5% of its operating profit in the US (i.e. only the Swedish Match business acquired last year). IQOS launch in the US will increase the contribution of the US market (US$) – but only towards the end of this decade. Meanwhile, as long as the long-term strengths of US$ (translational/reporting exposure; against €, ¥ and emerging market currencies) and CHF (transactional exposure; against every other currency) continue, PMI will be keep reporting negative currency variance (- as it did every year in the last decade, except for 2021).

We offered PMI’s new CFO the benefit of doubt. We expected him to take actions to minimize the above-mentioned adjustments: CHF cost base reduction, better hedging against US$ & CHF strength, better budgeting (covering – at least – a part of “so-called one-off, but actually pretty usual” expenses & charges), more accurate accruals, improved affiliate-level tax planning/management, etc. So far, he has kept the business running as usual: adjusting earnings in a way to deliver 10% adjusted growth.

The market is not happy with this situation. The discrepancy between the reported and adjusted EPS figures is the single most important reason why the PMI share price doesn’t break out to the upside despite all the positive news.

(2) Healthcare Endeavors

Although our financial assessment of PMI’s Wellness & Healthcare (W&H) segment is privileged & confidential (- see our proprietary research report), we can share our general view on the topic. We fully understand the business rationale behind PMI expanding into the Wellness category (i.e. functional consumer products) and we believe that PMI has both “right to offer (more)” and “right to win” in this area with a well-formulated strategy. We also understand exploring adjacent areas in the Healthcare category: NRT (Nicotine Replacement Therapies) and medical cannabis. However, extending further into Healthcare (cardiovascular, neurology, allergy, etc.) is far-fledged. “The Medicago/vaccine experience” should have served as a learning for PMI. We can’t understand how PMI Management believes that PMI has the “right to offer (more)” or “right to win” in the domains of cardiovascular, neurology, allergy, etc.

Most importantly, we foresee these Healthcare endeavors as focus diluting: while there is a trillion US$ recreational & functional consumer products market out there to conquer, why spend time & money on initiatives that could – at best – turn PMI into a product/technology supplier for major Pharma companies?

Difficulties in the Healthcare segment have already started to manifest themselves in PMI’s Q2 2023 earnings release. PMI recorded an asset impairment charge of $680Mn ($0.44 per share) and noted that the estimated fair value of the segment is below its carrying value, primarily reflecting: (1) the unsuccessful clinical trial results for the inhalable aspirin product, (2) slower-than-anticipated development of the contract development and manufacturing organization (CDMO) business. PMI also postponed its ambition to reach more than $1Bn net segment revenue in 2025.

As we expect that costly Healthcare R&D and business development projects will continue to eat into PMI’s bottom-line, we will closely follow the W&H strategy update to be presented at the PMI Investor Day (Sept 28, 2023).

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