Gross margin and free cash flow
Philip Morris’s (PM) gross margin decreased 0.7 points to 65.5% in 1Q16, compared to 66.3% in 1Q15. Despite the adverse currency impact, Philip Morris is focused on generating strong free cash flow in line with last year’s level. The company’s free cash flow (or FCF) increased by more than $300 million in 2015 to reach $6.9 billion for 2015.
Philip Morris’s (PM) reported operating income decreased 13.9% to $2.5 billion in 1Q16 compared to ~$3.0 billion in 1Q15. The decrease was primarily due to a negative foreign currency impact of $0.4 billion. However, on a constant currency basis, reported operating income decreased 0.9% in 1Q16.
The company’s adjusted operating income, excluding the unfavorable currency impact, decreased 0.9% in 1Q16. This was primarily due to an unfavorable volume mix of $0.2 million. This was due mainly to EEMA (Eastern Europe, the Middle East, and Asia) and higher costs in support of reduced-risk products. This was partially offset by favorable pricing and favorable volume mix in Latin America and Canada.
Operating margin versus peers
As a result of decreased operating income, Philip Morris’s operating margin fell 2.8% to 41.9% in 1Q16.
Altria Group (MO), Vector Group (VGR), and Reynolds American (RAI) are yet to release their 1Q16 earnings. However, Reynolds American’s 4Q15 operating margin increased 4.6 percentage points, to 41.2%, driven by an increase in adjusted operating margin for all segments. However, British American Tobacco’s (BTI) 2015 operating margin fell by 60 bps to 38.1%.
To learn more about Altria Group, please read An Inside-Out Breakdown of Altria Group, a Diversified US Tobacco Giant.
Pricing variance for 2016
Philip Morris expects a pricing variance of ~6% in 2016. This should help the company achieve a full-year pricing broadly in line with its historical annual average. However, during economic uncertainty, consumers purchase lower-priced brands. This significantly affects the volume of premium-priced and mid-priced brands and thus profitability. So higher prices could reduce volumes.
PM makes up 2.0% of the PowerShares S&P 500 High Dividend ETF (SPHD).[1. updated April 20, 2016]