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Will Philip Morris See an Improvement in Margins in 4Q15?

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3Q15 operating income

Philip Morris’s (PM) reported operating income fell 12.3% to $3 billion in 3Q15 compared to $3.4 billion in 3Q14. The decrease was primarily due to the negative impact of foreign currency of $0.7 billion. However, on a constant-currency basis, the reported operating income increased 9% in 3Q15.

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Adjusted operating income versus peers

The company’s adjusted operating income excluding the unfavorable currency impact increased 9.3% in 3Q15. This was due to favorable pricing, partially offset by unfavorable product volume and mix. As a result, adjusted operating income margin increased 1.4% in 3Q15 and 1.6% for the nine months ending September 30, excluding negative currency impact changes and excise taxes.

Similarly, Altria’s (MO) operating margin increased 10.2% to 46.3% in 3Q15. This was primarily due to an expansion in the adjusted margin of 2.8 percentage points to 47% in the smokeable products segment. Reynolds American’s (RAI) adjusted operating income also increased 64.9% to $1.4 billion in 3Q15 compared to $0.9 billion in 3Q14. The operating income increased primarily due to strong results delivered by RJR Tobacco’s new addition of Newport brand after Lorillard’s acquisition and related divestitures to Imperial Tobacco (ITYBY).

Increasing margins through increased prices

During 3Q15, revenue growth was partially impacted by lower volume or product mix of $0.06 billion mainly in the Asia region. However, According to CFO Jacek Olczak, the pricing variance of $1.6 billion through September will help the company achieve full-year pricing broadly in line with its historical annual average of approximately $1.8 billion.

During economic uncertainty, consumers purchase lower-priced brands, which significantly affects the volume of premium-priced and mid-priced brands and thus profitability. Thus, higher prices could reduce volumes. The company expects cigarette volume to decline by 1% to 1.5% for the full year 2015.

PM makes up ~1.0%[1. Updated as on January 25, 2016] of the iShares Russell Top 200 Growth ETF (IWY).

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