Philip Morris International: Zyn Driving Results And Controversy (NYSE:PM)

Last April, I placed a “Buy” rating on Philip Morris International (NYSE:PM), saying it had huge opportunity in front of it as it started to derive more and more revenue from higher margin smoke-free products. More recently in November, I said the company was a unique combination of growth and defense. With the company reporting results last month and some controversy around its Zyn product, let’s catch up on the name which has traded in a pretty tight range over the past year.

Company Profile

As refresher, PM is a tobacco company that sells cigarettes and other tobacco products in countries and territories outside the U.S. While it owns several brands, Marlboro is its largest cigarette brand, while IQOS is its largest overall brand.

The company is permitted to sell its nicotine pouch Zyn in the U.S. and bought back the rights from Altria Group (MO) to sell its IQOS heat-not-burn products in the U.S.

CAGNY Conference and Q4 Results

In late February, PM spoke about its opportunity in smoke free products at the CAGNY conference in New York. It noted that it get 2-2.5x better unit margins for IQOS compared to cigarettes, while its Zyn nicotine pouches have about 6x better unit economics than cigarettes. Smoke free products are now about 40% of its revenue, and it expects the segment to generate about $15 billion in revenue this year.

The other big opportunity for the firm will be introducing its IQOS product in the U.S. As a reminder, the company bought back the rights from MO in 2022 for $2.7 billion. MO had done little to commercialize the product in my view.

At the conference, CEO Jacek Olczak said:

“Our best strategy adoption is to do the full-blown launch of heat-not-burn in the U.S. based on ILUMA technology. And the only thing now which is standing in our way to do it, is [the] FDA. We have very recently also resolved the long-lasting IP conflict, if you like, which we have with BAT, which allows us now to essentially have the freedom to operate on the blade, but also on the ILUMA product going forward with the full access to international supply chain, which allows us to very rapidly tap into the economic benefit, which we have from the economy of scale on the international rather than start the whole IQOS presence in the U.S. from scratch. So, we will end up having a manufacturing footprint in the U.S. for IQOS. But at least now we have a freedom to plan it, what makes sense from the more financial economic perspective and immediately go and leverage what we have built on international. The first city test on still the blade product is planned, IQOS 3 is planned for the Q2. But again, our strategic attention and the focus is bring as fast as possible ILUMA into the market, because then we know it’s a completely different way of commercializing the product, different, even better than IQOS blade uptake, et cetera. So ILUMA should give us a path to the breakeven in the U.S. faster than we’ll have otherwise achieved if we start with the blade product.”

Turning to PM’s Q4 results reported last month, the company saw revenue rise 11.0% to $9.05 billion. That topped the consensus by $40 million. Organic growth rose 8.3%.

Combustible tobacco revenue grew 5.3% on a reported and organic basis. A 9.9% increase in pricing drove the results. Smoke-free product revenue jumped 21.1%, and was up 13.6% on an organic basis.

Total cigarette and HTU shipment volumes fell -0.5% to 185.1 billion units. HTU shipment volumes climbed 6.1% to 34.0 billion units, while cigarette volumes declined -1.9%.

In Europe, cigarette volumes were flat at 43.4 billion units, while HTU volumes climbed 10.0% to 14.3 billion. Revenue rose 18.0%, or 9.6% excluding FX and acquisitions, to $3.6 billion, while adjusted operating income rose 22.2% to $1.6 billion.

Its SSEA, CIS & MEA region saw cigarette volumes fall by -1.1% to 83.0 billion units, while HTU volumes soared 22.5% to nearly 7.5 billion. Revenue rose 0.8%, or was up 13.0% excluding FX and acquisitions, to $2.7 billion, while adjusted operating income fell -16.6% to $681 million.

Its EA, AU AND PMI DF region saw cigarette volumes fall by -8.5% to 11.3 billion units, while HTU volumes decreased -6.5% to 12.0 billion. Revenue fell -3.1%, or -0.1% excluding FX and acquisitions, to $1.4 billion, while adjusted operating income sank -17.3% to $561 million.

In the Americas, the company saw cigarette volumes decline by -5.2% to 17.5 billion units, while HTU volumes rose 4.7% to 202 million. Revenue edged up 1.7%, but was down -4.9% excluding FX and acquisitions, to $545 million, while adjusted operating income was -$78 million versus $95 million a year ago.

Oral product shipment volumes more than doubled to 213.6 million cans, helped by the acquisition of Zyn in November of 2022. Swedish Match’s total oral product shipment volume jumped by 21.9%. Zyn nicotine pouch volumes in the U.S. soared 78.2%. Revenue for the segment more than doubled to $682 million, and was up 21.2% organically. Adjusted operating income soared to $325 million from $129 million.

Gross margins increased by about 110 basis points to 61.7%.

Adjusted EPS rose 20.3% to $1.36, missing analyst estimates by 9 cents.

Looking ahead, PM forecast 2024 organic revenue to grow by between 6.5-8.0%. It is projecting adjusted EPS of $6.32-6.44. Excluding currency, it is projected adjusted EPS of between $6.43-6.55, representing 7-9% growth.

It’s expecting cigarette and HTU shipment growth, excluding the U.S. and China, of flat to -2%, and total volumes, including oral smoke products to be flat to +1%. It expects to generate between $10-11 billion in operating cash flow and spend $1.2 billion in capex.

For Q1, it is looking for adjusted EPS of between $1.37-1.42.

Zyn and IQOS continue to be the drivers for PM, which once again showed up in Q4. Both products come with much better unit economics than cigarettes, so the company benefits from any smokers that convert over. Meanwhile, Zyn continues to grow strongly in the U.S.

Cigarette volumes continue to decline, but PM continues to grow this part of the business through its pricing power. This allows the company to pretty consistently generate mid-single organic growth in this category.

The introduction of IQOS in the U.S. could be a growth driver for the firm in upcoming years. Since it does not sell cigarettes in the U.S., any new users would be completely new customers, not coverts, so the economics would be strong. However, given the popularity of vaping, it could be difficult to switch these customers over to IQOS.

Overall, the quarter for PM was solid. The company did experience some currency headwinds, but that is beyond its control. Organic revenue growth, however, was solid, and gross margins continued to expand as smoke-less products become a larger percentage of sales.

Valuation

PM’s stock currently trades around 12.1x the 2024 consensus adjusted EBITDA of $15.6 billion and 11.3x the 2025 consensus of $16.8 billion.

It trades at a forward PE of 14.9x the 2024 consensus of $6.37 and 13.6x the 2024 consensus of $6.99.

It’s projected to grow revenue by 5.7% this year and 6.4% in 2025.

The stock trades at a premium to its tobacco peers, although it is expected to grow a bit faster than them and doesn’t have U.S. cigarette exposure, which is a good thing for tobacco companies.

Historically, the company has largely traded between 12-16x EBITDA the past several years. That would value the company between $114-$146, which a midpoint of $130.

The company also pays a dividend of $5.20, good for a yield of about 5.5%.

Conclusion

PM’s cigarette business continues to be a steady grower through pricing with modest volume declines, while its smoke-less business delivers increased growth and better gross margins. At the same time, the company generates prolific free cash flow used to pay a generous dividend and to reduce debt.

Its fast-growing Zyn product, however, has recently come under more scrutiny with calls for it to be regulated and lawsuits over the product allegedly being targeted at children. At the same time, the product has become another political hot button issue, with conservatives pushing back on the calls of regulation. As such, while the product faces regulatory risks, I believe the recent political infighting and free press could actually help boost sales.

IQOS, meanwhile, is a big opportunity in the U.S., but it will likely take years to carve out a decent niche in the states given how popular vaping has become. Internationally, it should still be a gross margin driver.

Overall, while there may be some increased regulatory risk, I continue to view the stock as undervalued. I will boost my target slightly for $110 to $115, as the focus turns more towards 2025. The $115 is at the low end of my fair value range given the regulatory risk with Zyn and represents a 12x multiple on 2025 EBITDA.

The biggest risk to PM going forward is regulations hurting Zyn sales in the U.S. The biggest potential catalysts would be stronger Zyn sales from the controversy and IQOS taking off in the U.S. faster than expected.