Earnings Transcript for PM - Q3 Fiscal Year 2024

Operator: Good day and thank you for standing by. Welcome to the Philip Morris International Inc., 2024 Third Quarter Results Conference Call. At this time, all participants are in a listen-only mode. After the speaker’s presentation, there will be a question-and-answer session. [Operator Instructions] Please be advised that today’s conference is being recorded. I would now like to hand the conference over to your speaker today, James Bushnell, Vice President of Investor Relations and Financial Communications. Please go ahead.

James Bushnell: Welcome. Thank you for joining us. Earlier today, we issued a press release containing detailed information on our 2024 third-quarter results. The press release is available on our website at www.pmi.com. A glossary of terms, including the definition for smoke-free products as well as adjustments, other calculations and reconciliations to the most directly comparable U.S. GAAP measures for non-GAAP financial measures cited in this presentation are available in Exhibit 99.2 to the company’s Form 8-K dated on today’s date, and on our Investor Relations website. Today’s remarks contain forward-looking statements and projections of future results. I direct your attention to the Forward-Looking and Cautionary Statements disclosure in today’s presentation and press release for a review of the various factors that could cause actual results to differ materially from projections or forward-looking statements. It is now my pleasure to introduce Emmanuel Babeau, our Chief Financial Officer. Over to you, Emmanuel.

Emmanuel Babeau: Thank you, James, and welcome everyone. Following an excellent first half we delivered another outstanding performance in Q3. All key elements of the business performed at or above expectations, driving strong double-digit organic top and bottom-line growth, margin expansion and a significant acceleration in adjusted diluted earnings per share growth in dollar terms. As expected, both IQOS and ZYN accelerated on a sequential basis. IQOS delivered a significant step-up in HTU adjusted IMS volumes in Q3, which is historically a quarter impacted negatively by seasonality. This reflects the strong underlying momentum of the business, with adjusted IMS close to plus 15% ahead versus prior year with another very strong performance from Japan, reaccelerating momentum in Europe, and promising results from a number of global markets. With ZYN, we continued our efforts to increase U.S. production capacity in response to strong demand, enabling stabilization of share performance followed by sequential improvement throughout the quarter. This led to a significant increase in sequential U.S. volumes, with over 40% year-on-year growth despite capacity constraints. Outside the U.S. nicotine pouch can volumes grew by close to 70%. Our combustibles business also accelerated to high single-digit net revenue and gross profit growth, led by further very strong pricing, resilient volumes and the benefits of our cost actions. Our overall Q3 performance epitomizes the soundness of our strategy, with underlying momentum across categories with strong volumes, pricing and smoke-free mix supported by cost efficiency measures. With double-digit growth in both adjusted operating income and diluted earnings per share in currency-neutral and dollar terms, we are raising our full-year guidance. Turning now to the headline financials for Q3. We delivered excellent organic revenue growth of plus 11.6%, driven by shipment volume growth of plus 2.9%, positive smoke-free category mix and pricing. The combination of this positive top-line performance with the additional favorable smoke-free mix impact on profits and ongoing cost efficiencies, enabled us to achieve growth of plus 13.8% in organic operating income and plus 18.0% in currency-neutral adjusted diluted earnings per share. This excludes an unfavorable currency impact of $0.06, notably due to weakness in the Egyptian Pound, Argentine Peso and the strong Swiss Franc, partly offset by the Japanese Yen. Despite the currency headwind, our proactive measures on pricing and accelerated cost initiatives drove plus 11.2% dollar growth in adjusted operating income and plus 14.4% dollar growth in adjusted diluted earnings per share to a record $1.91. This better-than-expected earnings delivery reflects IQOS and ZYN shipment volumes at the higher end of our expectations and a very strong combustibles performance. In addition we benefitted from a lower net financing cost, including increased interest income as well as mark-to-market gains on derivatives that we use to manage the currency profile of our debt, driven by interest rate volatility. Combined with an excellent H1, this yields an impressive plus 17.2% year-to-date currency-neutral growth in adjusted diluted earnings per share, with double-digit organic top-line growth and 190 basis points of organic opening income margin expansion. Including currency, we delivered adjusted earnings per share growth of close to plus 8% which is a testament to our continued focus on delivering strong performance in dollar terms. Let’s turn to the Q3 financial performance by category, with both sides of the business producing excellent results. Smoke-free net revenues and gross profit grew organically by plus 16.8% and plus 20.2% respectively, driving 200 basis points of gross margin expansion. This reflects a robust IQOS performance in the quarter including manufacturing productivities, as well as the continued accretion of ZYN and a small but growing contribution from VEEV. Smoke-free gross margins were more than 450 basis points higher than combustibles in Q3 and more than 200 basis points higher year-to-date. Combustible net revenue and gross profit growth accelerated to almost plus 9% organically. Combustible gross margins improved by plus 10 basis points organically and by plus 20 basis points in dollar terms, marking the second quarter of expansion following a challenging 2023. We continue to target combustible gross margin expansion for the year in organic and dollar terms as cost pressures, including the impact of the EU single-use plastics directive, are more than offset by pricing and ongoing cost initiatives. Focusing now on volumes, we are well on track for our fourth consecutive year of volume growth. Our business delivered a remarkable performance of around plus 3% total shipment growth both in Q3 and year-to-date, with all categories and all four regions growing over both periods. Q3 HTU adjusted IMS growth of plus 14.8% reflects the underlying dynamism of our IQOS business, with a continued strong performance in Japan and a reacceleration in Europe as expected. Q3 HTU shipments of 35.3 billion units were at the upper end of our expectations, with the superior adjusted in-market sales growth compared to shipments due to shipment phasing, as highlighted in H1. Our oral smoke-free business grew Q3 shipment volumes by plus 22.2%, with ZYN powering U.S. growth of plus 41.4% and very strong international performance. Our VEEV e-vapor business exhibited continued volume momentum in the quarter, reaching the equivalent of 1.2 billion units on year-to-date basis. Q3 cigarette shipments grew by plus 1.3%, outpacing the total estimated international cigarette industry excluding China and the U.S. at plus 0.5%. The unusually resilient industry performance this year reflects growing volumes in markets where smoke-free products are not permitted such as Turkey, India and Brazil, alongside a reduction in illicit volumes in a number of markets driven partly by geopolitical factors. Our growth includes notable contributions from Turkey, India and Italy and reflects good category share performance despite robust pricing. Our exceptional Q3 revenue performance reflected our three structural pillars of top-line growth

Operator: [Operator Instructions] Our first question comes from Bonnie Herzog with Goldman Sachs. Your line is open.

Bonnie Herzog: All right. Thank you. Hi Emmanuel hope you are well?

Emmanuel Babeau: Good morning, Bonnie.

Bonnie Herzog: I have a question on IQOS. I wonder if you could maybe comment a little bit further on the expected volume trajectory for IQOS, shipment volume growth did decelerate to the high single-digit range in Q3 from double-digit history. So I know there were some timing impacts and seasonality. But just could you maybe update us a little bit further on that in the quarter than maybe how that will reverse in Q4. And then also hoping for more color on volume, IQOS volume that is in East Asia, which has also decelerated just the drivers of that and whether you expect shipments to improve in the region in Q4?

Emmanuel Babeau: Sure, Bonnie, with pleasure, and you’re giving me the opportunity to maybe be back on the fact that when you look at IQOS, I really urge you to watch at the in-market sales, the adjusted in-market sales, which is the best proxy we can have from consumer off-take. And on that indicator, the good news was the confirmation of the reacceleration that we were expecting and we have been flagging the fact that we’re expecting accelerated momentum on IQOS in H2. And we are indeed seeing that in our Q3 adjusted in-market sales because we are almost at 15%. You were asking the question about East Asia. Actually, Japan delivered again around 14% of adjusted in-market sales. So the market for IQOS remain extremely dynamic despite the fact that we have, of course, already close to 30% market share, but we continue with strong double-digit, and that was a very good news. What happened in Q3 to explain the acceleration is, as I said, continued very strong dynamism in Japan. By the way, South Korea is also doing well. And we – I think we are showing the number in Seoul where we are nicely growing the market share. Then there was a reacceleration in Europe. And I know that we received a lot of questions, okay, how confident can you be in the fact that Europe is going to reaccelerate. We knew that we were going through this transition phase for the flavor ban. And we see the market progressively exiting the disruption of the ban with the reacceleration. Italy was, of course, during the third quarter, the country with the reacceleration and that was nice to see Italy clearly restarting on a very strong foot, the growth on IQOS. And we resumed double-digit growth on adjusted AMS in Europe in Q3. And then you have a number of other markets in the world. And I would say we see momentum here building up, which is very good news for the future. I could mention, of course, Indonesia, Saudi Arabia, Mexico, I think EU here as well. I mean, we see a number of markets where there is – and of course, Egypt, but Egypt has been now for more than a year with growth, where we see real momentum emerging behind IQOS which, of course, we’re just at the beginning. So a lot of potential but that is very encouraging on the fact that we have nice growth relay outside Japan and EU for the future. So that’s really what we’ve seen in Q3. Now you have the question on the shipment. Well, we’ve been flagging the fact that shipment would be – trajectory would be disconnected from the consumer off-take. We had some very strong growth in the first two quarters, which was notably driven by comparison year-on-year. There was, of course, a Red Sea disruption that generated some shipments in the first part of the year. And therefore, today, we have shipments that are a bit lower for the third quarter than the adjusted IMS. And we’re just, if you want, here for the nine months going to a situation where gradually, we are equalizing adjusted IMS and the shipments. So that’s what we are seeing. And in Q4, we’re going to be with more equalization because we’re going to be facing two elements. The first one, regarding the Red Sea disruption, we’re going to have some reversal in Q4, so that will play negatively on the shipment. And we also are facing some high comps last year as we are building inventory to prepare the transition for the flavor ban in Europe. So that’s a high comps in time of shipments last year. But at the end of the day, you should expect adjusted IMS and shipments through a certain period to evolve in parallel way. And as we said, we continue to expect, for Q4, a renewed momentum on a consumer off-take or what we call adjusted market sales, which is really what matters. That’s what is important because that’s what is talking about the health of IQOS.

Bonnie Herzog: Yes. Okay. All of that makes sense and it’s really helpful. Thank you. And then maybe a second question on ZYN. So the supply constraints appear to be easing, which is great. So I just wanted to confirm, Emmanuel, that you are on track to fully restore supply levels this quarter? Or is there a chance this bleeds into maybe early next year? And then when this happens, how quickly do you expect ZYN to recapture some of the lost market share? And just curious what role will potential stepped up promos play, I guess, if at all? How are you thinking about that? Thank you.

Emmanuel Babeau: Sure. On ZYN, Bonnie, we said somewhere in Q4, we will have the supply to the market, meeting consumer demand, which to clarify again, doesn’t mean that we will have fully been replenishing all level of inventory. Here at that point, we believe for what we can assess of the consumer demand that what we bring to the trade will correspond to what the consumer will take from the trade, will buy from the trade. But then there will certainly be – and I’m not able to tell you what is going to happen during this quarter. But I think we are still in this perspective then, but that’s probably more for 2025, there will be a replenishment of the out-of-stock situation. And we will gradually – but that’s going to happen only gradually probably through 2025, put back the level of inventory to what it should be normally and that certainly will take some months as we continue to increase the capacity. Remember, we said that for the full year 2025, we are targeting an overall capacity of around 900 million can. Of course, that is a capacity that we are going to build gradually. It won’t be there at the beginning of the year. And I would say the replenishment and being back to a fully normal situation is going to happen only gradually through 2025. And of course, when we can be more specific about that, we will be more specific with the topic. So that’s for supply. When it comes to regaining share, so what we’ve seen is that, in fact, when the availability of ZYN went down, we’ve seen the category slowing down because, obviously, it seems that a number of buyer of ZYN are not intending to buy another brand. And therefore, when they don’t find their ZYN, they are maybe producing or consuming something else. But that probably has been slowing down a bit the category. We will see how we gradually recover. We’ve seen in the second part of the Q3, some improvement sequentially on our market share, which is good news. We believe that we have some positive outlook as we regain availability for the product, but it’s difficult to be more specific than that at that stage.

Unidentified Analyst: All right, thank you. I will pass it on.

Emmanuel Babeau: Thank you.

Operator: Thank you. And our next question comes from Gaurav Jain with Barclays. Your line is open.

Gaurav Jain: Hi. Good morning, Emmanuel.

Emmanuel Babeau: Good morning, Gaurav.

Gaurav Jain: A couple of questions from me. So just looking at the cigarette markets internationally, your pricing guidance, you have increased 8% to 9% and yet volumes are positive. The factors that you’re mentioning why volumes are so strong, which is lack of SBD in Brazil and Turkey, lack of smuggling probably from Russia, Belarus, all these countries. They should continue in FY 2025. So shouldn’t then FY 2025 also be a pretty strong year for cigarette volumes and pricing internationally. And within that context, can you also touch on if there are any disruptive excise tax hike happening in the next few months?

Emmanuel Babeau: Thanks, Gaurav, for your question. So I don’t want to enter now into commenting 2025. And of course, in due course, we’ll share with you on the outlook for the year. I think what we are seeing in 2024 is well-identified. We talk about a number of markets where smoke-free products are not allowed. Sometimes you have increasing the prevalence, sometimes you have demographics that are playing positively for the consumption of cigarettes. I think India is a clear market when it comes to demographic, for instance. And it’s difficult to say how long all that is going to play and what’s going to be the continuation of this trajectory. I think we need to be a bit cautious on the outlook, but it’s true that I cannot say that everything will finish on the 31st of December 2024. So we don’t know what’s going to be the trajectory in 2025. What is certainly good is to see that we are able to actually grow volume, grow share of segment and, at the same time, increase price in a very dynamic manner, which is a tribute to the strength of our brand, and it’s true that the 9.7% in Q3 was a remarkable price increase. Don’t take that for Q4 as a guidance, but that was very good in Q3. And that shows that in this category, where I think we’ve been clear on our objective, which is really to maximize the performance on combustible in order to accompany and help the fastest transition to smoke-free. I think this strategy on combustible is working and delivering. And remember, we also said that in 2025, we expect a number of positive evolution for combustible cigarettes when it comes to cost of goods, where we’ll have a lower level of headwinds. So there will be continuation of price increase in the future without a doubt. Nevertheless, don’t take the 8% to 9% as the guidance for the future. We always said that we were more mid-single digits on the medium term. And we should see less headwind on cost of goods, which is probably good for the combustible cigarette profitability. On excise tax, at that stage, there is nothing really material I can report, I would say, traditional discussion, but we’re still a bit early. You know that many, many decisions are made in November, if not in December, so probably we’ll know more at the end of the year. But so far, I would say nothing specific or unusual to flag.

Gaurav Jain: Sure. Thank you. And my second question is on your e-cigarette comments. So what you told us is that you have shipped 1.2 billion sticks year-to-date. And if I understand correctly, you are using the conversion factor is 1 ml is 10 sticks. And if I assume 1 pod is 0.7 ml then you’re shipping 160 million pods. So that would suggest that your e-cigarette revenue run rate is $300 million to $400 million, at which your contribution basis breakeven. So am I ballpark correct and all these numbers are done?

Emmanuel Babeau: Yes, I can certainly confirm that 1 milliliter equates to 10 sticks, 10 cigarettes. That’s the equivalent. And I would say that ballpark, I’m not going to confirm exactly, but you are not million miles away from the reality on volumes. On revenue, I won’t comment.

Gaurav Jain: Sure, thank you so much.

Emmanuel Babeau: Thank you.

Operator: Thank you. Our next question comes from Faham Baig with UBS. Your line is open.

Faham Baig: Hi, Emmanuel. Hi, James. Thanks for taking my questions. A couple from me, please. I want to start with vapor, particularly because one of your peers highlighted that in Europe vapor is seeing greater success in sort of fully converting smokers than heated tobacco. I know I’ve asked this before, but I wanted to get your latest thoughts on this topic as well as whether you’re seeing an acceleration in vapor adoption as you sort of roll out VEEV in several markets. And the second question goes back to nicotine pouches in the U.S. I noted in your prepared remarks, you’ve also seen some illicit products coming into the market. Some of that may be infringing your patents. Could you just maybe expand on what measures you are currently taking or expect to take? And how do you think this will differ from the current environment we see in vapor in the U.S., please?

Emmanuel Babeau: Sure, Faham. With pleasure. So on greater success from vaping in convincing smoker, we don’t see any of that. The experience is very different. It’s quite obvious that versus heat-not-burn, heating a liquid, which has no tobacco is delivering a very, very different experiences. And I think all markets are pointing to the fact that there is clearly a much, much higher and much better conversion from smokers to heat-not-burn into vaping. And I think the success of IQOS is brightly illustrating that, I have to say, I’m not coming back on the performance on IQOS. I don’t think we are really seeing an acceleration in the adoption of vaping. The vaping market, the vaping category is impacted today by many, many regulation evolution or potential evolution. We know that one of the problems of the vaping category is that you have a responsible player going for fancy flavor, unacceptable marketing behavior that can generate underage consumption that can be creating some disruption. We know that notably the disposable category has been generating some of that. But if you look at the – what we can say of the legal age nicotine user, I don’t think that we can report any acceleration that would be meaningful from vaping. Regarding the nicotine part in the U.S., and your question on what we do, can you first allow me a general comment? I think that PMI is at the forefront, at the very forefront when it comes to fighting illicit trade. And that is true for the U.S., that is true everywhere in the world. We commit huge resources, I mean, investments in fighting illicit trade, working with authorities, regulators in many countries to do that. And for us, it’s a very, very important battle, a very important fight. So, the U.S. make no exception. And yes, when we are aware of illicit, when we are aware of product infringing, potentially our patent, we are acting. I think that in my remarks, I signaled some of the things that we do. When we identified the sources that are potentially outside the U.S. we could go to even terminating sales to these sources. I said it. We are working with distributors. It can be informing, creating the awareness for illicit product writing to distributor. It can be sending cease and desist letter to distributor retail where we see an issue. And we do that on our own or working with the regulator, as I said, in the U.S. like everywhere in the world. So you can be sure that we take that extremely seriously.

Faham Baig: Thanks, Emmanuel.

Emmanuel Babeau: Thank you very much.

Operator: Thank you. [Operator Instructions] Our next question comes from Priya Ohri-Gupta with Barclays. Your line is now open.

Priya Ohri-Gupta: Hi Emmanuel, thank you so for receiving me.

Emmanuel Babeau: Hi, great.

Priya Ohri-Gupta: Just two quick ones from me. First, it does look like you modestly sort of took down the top end of your potential deleveraging for this year by a little bit if you could address sort of what drove that? And then secondly, you do have a fairly sizable amount of maturities over the course of 2025. Any thoughts on pulling some of that refinancing forward into the remainder of this year, just given where markets are opportunistically? Thank you.

Emmanuel Babeau: Yes, taking these two questions with pleasure. So, on the slightly and very modestly narrowing the guidance for deleveraging, it’s because of the euro strength at the end of September that was – because as you know, we have a significant part of the debt in euro and therefore, when the euro is going up versus the dollar, that can have a kind of one-off element because we always have this discrepancy between an EBIT that is calculated on an average rate for the year when the debt is going to be calculated on the spot on the 31 of December. So we’ll see where we land. But the trajectory is clear. And you may have seen that at the end of the third quarter, we have generated cash flow of $8.2 billion, and that is simply $2.3 billion above the cash flow generation at the end of Q3 2023. So, we are highly generating cash, of course, on the back of a very strong momentum in the business, but that’s good news. Yes, I mean, I am certainly not going to discard the possibility for us to be active on the refinancing market in the coming months. I am not going to elaborate now on that, and we have a number of options that are open to us. But you can be sure that we are already working on how to put in place the best refinancing again in the coming months for PMI.

Priya Ohri-Gupta: Thank you so much.

Emmanuel Babeau: Thank you.

Operator: Thank you. Our next question comes from Gaurav Jain with Barclays. Your line is open.

Gaurav Jain: Guys, just a follow-up on the Canadian litigation settlement. Would these payments be tax-deductible? And when do you think something final will happen in this long run in sort of COVID case?

Emmanuel Babeau: Thank you, Gaurav. On the Canada litigation, so you have what we can say at that stage in our press release that we have issued last week. It’s too preliminary. And as I said, I am not able to tell you whether it’s going to be tax-deductible. Of course, as soon as we know we will let you know. But for the time being, I am not able to say. And as you may have seen in our release, where we shared what we can share at that stage, there are still a number of elements in this proposed solution put on the table by the mediators to be finalized. And of course, once we have the final terms, we will come back to you with this answer, of course, but also all the question on what’s going to be the impact for PMI of a final settlement.

Gaurav Jain: Thank you so much.

Emmanuel Babeau: Thank you.

Operator: Thank you. I am showing no further questions at this time. I would now like to turn it back to James Bushnell for closing remarks.

James Bushnell: Thank you for joining us today. Please reach out to the Investor Relations team if you have any follow-up questions. I am wishing you a good rest of the week and earnings season.

Emmanuel Babeau: Look forward to speaking to you soon. Thank you. Have a great day.

Operator: This concludes today’s conference call. Thank you for participating. You may now disconnect.