Louis C. Camilleri, Chairman and Chief Executive Officer of Philip Morris International Inc., highlights the company’s key achievements in 2010 and reaffirms the company’s steadfast commitment to deliver superior returns to its shareholders at the Annual Meeting of Stockholders in New York.
May 11, 2011
Louis C. Camilleri, Chairman and CEO
2010 was a challenging year as we had to deal with unprecedentedly high excise tax increases in six important markets, the impact on consumer sentiment of stubbornly high and rising unemployment levels in several European markets, and an increase in illicit trade. Even in this environment, our financial results were robust. EPS growth was solid and a significant reduction in working capital helped to drive a very strong increase in our cash flow. This in turn allowed us to continue to generously reward our stockholders. Last year, we increased our dividend by a further 10.3% and spent $5.0 billion to repurchase an additional 97.1 million of our shares.
In 2010, PMI’s cigarette volume reached just under 900 billion units, an increase of 35.8 billion units, or 4.1%, compared to 2009, driven by our business combination in the Philippines. On an organic basis, volume was down by 2.5%, mainly reflecting the impact of lower industry volume, due to disruptively high excise tax increases in Australia, Greece, Japan, Romania, Turkey and Ukraine, as well as a very difficult economic climate particularly in Spain.
Our net revenues totaled $27.2 billion in 2010, up by 8.7%, and by 3.4% excluding both currency and acquisitions. This was driven by our strong pricing power and was based on our brand leadership and broad portfolio.
Adjusted OCI was $11.5 billion in 2010, an increase of 10.3%, and 5.8% excluding currency and acquisitions.
Adjusted diluted earnings per share reached $3.87, representing an increase of 17.6%, and 14.0% excluding currency.
During the first quarter of 2011, our cigarette volume grew 1.6%, driven by our business combination in the Philippines. Our organic volume was unfavorably impacted by anticipated softness in Japan, Mexico, Pakistan, Spain and Ukraine, as well as by the events in North Africa, and was consequently 3.3% lower.
During the quarter, we further reinforced our position in our key markets, and our share in our top 30 OCI markets was up 0.5 points compared to a year earlier, despite continued high unemployment levels and fiercer price competition.
Marlboro’s performance continues to strengthen on a global basis, as shown by its positive market share trend.
Net revenues in the first quarter increased by 4.5%, and by 2.7% excluding currency and acquisitions, as higher prices more than offset the impact of lower volumes.
During the same period, our adjusted OCI grew by 11.4%, and by 8.0% excluding currency and acquisitions.
Strong pricing, most notably in Japan, as well as our continued focus on productivity improvements, resulted in an increase of 2.2% points during the first quarter in PMI’s adjusted OCI margin, excluding currency and acquisitions. The decline in the EEMA Region was entirely attributable to a significant income windfall earned in the prior year period.
Our strong business results and our share repurchase program enabled us to increase adjusted diluted EPS by 17.8% in the first quarter, and by 14.4% excluding currency.
Our improved business outlook and more favorable exchange rates led us, on April 21st, to increase our reported diluted EPS guidance for 2011 by 20 cents to a range of $4.55 to $4.65.
Compared to an adjusted diluted EPS of $3.87 in 2010, this corresponds to an increase of approximately 17.5% to 20% at prevailing exchange rates, and approximately 12.5% to 15% excluding currency. This 2011 EPS guidance represents a rate of growth that is superior to the mid to long-term currency neutral annual growth target that we established at the time of the spin.
We have generally performed very well against our annual mid to long-term financial targets, which are 4 to 6% net revenues growth, 6 to 8% adjusted OCI growth and 10 to 12% adjusted diluted EPS growth, all excluding currency, and net revenues and OCI also excluding acquisitions.
We did achieve our 1% organic volume growth target in 2008. Since then, we have generally outperformed the industry, but have been impacted by unfavorable cigarette industry volume trends outside of China and the USA, resulting from unreasonable tax increases and a weak economy. We estimate that industry volume declined by 1.6% in 2009 and by a further 2.2% last year.
The key drivers of our strong financial performance since the spin are our superior brand portfolio and global infrastructure, our success in completing strategically and financially attractive business development projects, strong pricing, the evolution of tobacco leaf prices, and productivity and cost savings.
Our brand portfolio is composed of leading international and local heritage brands, covering all profitable price segments.
We own seven of the top 15 international cigarette brands.
These are led by Marlboro, the only truly global cigarette brand, which has been re-invigorated by the development and roll-out of the new architecture and consumer-relevant line extensions.
Parliament, usually sold at an above premium price, complements Marlboro and is performing very well in a number of markets, in particular in Eastern Europe. Parliament volume increased by 9.0% in the first quarter of this year, and achieved a 7.5% market share in Turkey and 6.0% in Korea.
Chesterfield volume was lower in the first quarter, due to the impact of difficult economic conditions on consumer behavior in Spain and the Ukraine. We have modernized the brand offering and the brand is growing rapidly in Austria and Portugal and continues to expand its market share in Russia.
L&M had a strong start to the year with volume up 1.5% on a global basis in the first quarter and growth in all four Regions. The key driver of this performance was share gains in Turkey, Greece, Brazil, Germany, Romania and Thailand, while the brand continues to be weak in Eastern Europe.
The strength of our brands and our superior global infrastructure, complemented by geographic expansion through business development projects, has enabled us to establish ourselves as the leader in both the top ten non-OECD markets, excluding China, and the top ten OECD markets, excluding the USA.
Pricing has been the key driver of our increased profitability, adding a cumulative $4.9 billion over the three year period.
In 2008, we were faced with a significant increase in leaf prices as several years of depressed prices led to a global under-supply of tobacco. This had an immediate effect on our cash flow, while the unfavorable flow through to the P&L was more gradual, impacting 2009 and 2010 in particular.
We have taken several measures to prevent such swings in supply from recurring. The most notable step was our investment in greater vertical integration in Brazil, where we have significantly increased the scope of our direct contracts with farmers with a view to ensuring that the sustainability of the price/quality equation is enhanced. In 2011, we expect tobacco leaf prices to be stable, driven mainly by a larger crop in Brazil, and we forecast that prices over the next few years should increase in line with inflation.
Sustainable tobacco growing is of course about more than the quality and the price of the crop. It is also about protecting the environment and ensuring labor practices that promote the safety, well-being and social and economic security of tobacco farmers and workers. Specifically with respect to labor practices, we are committed to achieving safe and fair working conditions on all farms from which we source tobacco and to progressively eliminate child labor and other labor abuses where they are found.
With this objective in mind, we have undertaken both an internal and third party review of our practices and policies worldwide. In doing so, we have sought the advice of local and international non-profit organizations with expertise in the area of fair labor practices.
We are now in the process of implementing a strong, comprehensive Agricultural Labor Practices Code, which strengthens and expands our existing practices and policies. This Code and its supporting programs go well beyond child labor and worker safety and will also vigorously address issues such as work hours, wages, migrant worker treatment, and potential forced labor situations. Among other things, this includes tailored, in-depth training programs for our tobacco crop professionals and suppliers, farmers and their workers; as well as external third party assessments to monitor the progress we’re making. As we previously announced, these assessments, as well as information about our labor practices, are available on our website.
Of course, as the International Labor Organization recognizes, eliminating child labor and other labor abuses that stem from systemic issues such as poverty and lack of education, requires the serious and lasting commitment from everyone in the supply chain, as well as governments and other stakeholders. Accordingly, we are continuing to work with a range of governmental and nongovernmental organizations in our tobacco growing markets, including our significant contributions in the field of poverty eradication and education.
We were able to more than offset tobacco cost increases over the last three years through the successful completion in 2010 of the $1.5 billion productivity and cost savings program that we announced at the time of the spin. Key elements of the program were the repatriation of production from the USA to Europe, the further optimization of our manufacturing footprint, the streamlining of tobacco blends and product specifications, the establishment of service centers in Poland and Argentina for finance and human resources, and a rationalization of back office support functions and staff in the European Union Region.
The two key challenges that we face in our business are excise taxation and regulation.
The global outlook for excise taxation this year is more favorable than in 2010. Most governments have implemented reasonable rate increases with Mexico the only major market to have raised excise taxes disproportionately. Moreover, a number of countries in the EU have introduced structural improvements in their excise tax systems and both the Czech Republic and Germany have new multi-year excise tax programs. Excise taxation will nevertheless remain a key factor influencing the profitability of our business going forward.
One of our important long-term strategies is the pursuit of comprehensive regulation and fiscal policies that govern the manufacture, marketing, sale and use of tobacco products, based on the broader goal of harm reduction. This strategy is explained in depth on our web site and I encourage you to visit it to learn more about the company’s commitment to addressing the complex issues surrounding tobacco use.
We have successfully managed regulatory challenges in the past, such as public smoking restrictions, marketing constraints, graphic health warning labels and the ban on descriptors in many markets. In fact, we have largely supported these measures within the framework of comprehensive, effective and uniform tobacco regulation.
We do not, however, support regulation that prevents adults from buying and using tobacco products or that imposes unnecessary impediments to the operation of the legitimate tobacco market.
Unfortunately, the three most recent regulatory proposals, namely product display bans, bans on the use of ingredients and plain packaging, go in this direction. There is no sound evidence that any of these measures would reduce consumption, smoking incidence or youth smoking or provide any other public health benefit. Furthermore, these measures ignore the considerable severe adverse consequences, such as impeding competition, imposing significant costs and other burdens on retailers, encouraging adult smokers to make choices based on price rather than product characteristics, and fostering the illicit trade in tobacco products.
The most critical of these proposals is plain packaging. The current Australian Government seems determined to be the first to introduce such a measure, despite its rejection when studied previously, and has released an exposure draft of its plain packaging bill for consultation through June 6th. This bill would mandate plain packaging in 2012.
PMI is firmly opposed to such a measure as there is no credible evidence that it will achieve any reduction in smoking rates, and the Government has ignored the fact that it may actually be counterproductive to public health. Plain packaging will lead to price erosion over time and will further encourage the growth of illicit trade, which already increased in Australia by over 25% in 2010, according to a recent Deloitte study. Plain packaging will also result in the illegal confiscation of our trademarks and branded assets, in violation of international trade laws and treaties.
Unlike other Governments, which have focused on establishing whether there is any credible evidence to demonstrate that plain packaging would have public health benefits after taking into consideration issues such as competition, trade and legal implications, as well as the likely impact on illicit trade, the Australian Government seems to be forging ahead without due consideration of any of these important issues. PMI will take all measures it deems appropriate, including recourse to the courts if necessary, to oppose the Australian Government’s proposal.
The key goal of our business strategies is to increase our cash flow. At the time of the spin, we established an ambitious target to generate a cumulative operating cash flow of $21.7 billion over three years. We surpassed that objective by $3.5 billion, or 16%.
This was helped by the establishment of a three-year working capital reduction program in November 2009, which targeted savings of $750 million to $1 billion. The main focus of the program was tobacco leaf and finished goods inventories. It was supported by a $15 million investment in systems. A reduction of approximately $1 billion in total working capital was in fact achieved by the end of December last year, two years ahead of target.
We seek to use the cash that we generate to reward our stockholders generously. Last September, we increased our dividend by a further 10.3% and, since the spin, the cumulative increase has reached 39%.
This has been complemented by a two-year $13 billion share repurchase program that we completed in April last year, and a second three-year $12 billion program that is scheduled to run through the end of April 2013.
Since the spin, we have used a total of $17.3 billion to repurchase 355.7 million shares, representing 16.9% of the shares outstanding at the time of the spin.
Our strong financial performance and the judicious use of our growing cash flow have been appreciated by our stockholders, who have driven the share price of PMI up by 36.0% between the spin and the end of last month. This compares very favorably to the 3.7% appreciation of the S&P 500 over the same period.
Once the reinvestment of dividends is taken into consideration, the total PMI post-spin shareholder return was 57.7% through the end of April this year, a performance well ahead of our industry peers and the market as a whole. This year alone, the total shareholder return that we have generated is a superior 19.8%. This reflects not only our achievements over the last three years, but the confidence that you, our stockholders, have shown in our ability to continue to grow profitably, generate a generous return and remain a very attractive investment.
Charitable Giving Overview
Philip Morris International operates in more than 180 markets worldwide and we employ more than 78,000 people.
Our employees are an integral part of the communities in which they live and work. It is their recommendations which begin the process by which we select our charitable giving programs around the world. This is because they are best placed to recognize their communities’ needs, given their inherent understanding of their environments, close relationship with local non-governmental organizations and, often, their own desire to volunteer themselves on projects to help improve the well-being of their fellow citizens.
In some cases, these factors converge around an urgent need for assistance, as was the case earlier this year when we announced our $1.2 million donation to the broad relief efforts following the tragic events in Japan. In others, the object of our charitable giving has historically deeper roots.
One such example can be found in Russia and the former city of Leningrad, now St. Petersburg, home, since 1998, to one of our two factories in the country.
In late 1941, the city of Leningrad came under siege where it was to remain for some 900 days, a period in its history that was marked by tremendous suffering. Today, Russian government officials and citizens alike are troubled by the fact that so many of their war heroes now find themselves impoverished.
To assist this group, Philip Morris Russia funds multiple programs to provide basic food and other items to nearly 19,000 veterans. Many of our local employees, together with their families, participate in these programs by visiting these veterans to personally deliver donations as a mark of respect for their remarkable heroism and personal sacrifice.
One such program, called “A Day of Kindness,” takes place around the anniversary of the lifting of the Leningrad siege on January 27, 1944. I invite you to watch a brief video highlighting this year’s event.
Last year, more than three million people benefited from PMI grants covering the areas of hunger and poverty, education, domestic violence, environmental sustainability and living conditions, and disaster relief. As part of that assistance, our employees participated in charitable programs in over 30 countries. Please join me in applauding, with deep gratitude, their hard work, dedication and professionalism, without which our company would not be what it is today.
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