Remarks for 2010 Annual Shareholders Meeting by Louis C. Camilleri

Philip Morris International Inc. (NYSE / Euronext Paris: PM) held its 2010 Annual Meeting of Stockholders today. Louis C. Camilleri, Chairman and Chief Executive Officer, highlighted the company's key achievements in 2009 and reaffirmed the company's steadfast commitment to deliver superior returns to its shareholders.

May 12, 2010

Louis C. Camilleri

Louis C. Camilleri

Business review

Despite the impact of the global recession and rising unemployment on industry volume, PMI achieved strong financial results in 2009. This resilient performance was in part masked by significant currency headwinds. Of particular import was our ability to generate operating cash flow that was well ahead of the three-year projection that we made at the time of the spin. This enabled us to return $10 billion in 2009 alone to our shareholders through our dividend and share repurchase program. 

In 2009, PMI’s cigarette volume reached 864.0 billion units, a decline of 5.7 billion units, or 0.7%, compared to 2008. On an organic basis, that is excluding the impact of acquisitions, volume was down 1.5%, mainly reflecting the impact of lower industry volume, due to the economic downturn and in particular higher unemployment in such markets as Russia and Spain.

We successfully grew our market share last year in both the more developed OECD markets, as well as in the emerging non-OECD markets.

Our net revenues, excluding excise taxes, totaled $25.0 billion in 2009. Net revenues increased by 7.5%, excluding currency, or by 5.3% excluding both currency and acquisitions.

Adjusted Operating Companies Income, or OCI, was $10.4 billion in 2009. This represented an increase of 11.1% excluding currency, or 8.7% excluding currency and acquisitions.

Adjusted diluted earnings per share, or EPS, of $3.29, were marginally below the previous year’s level due to 53 cents of unfavorable currency. On a constant currency basis, adjusted diluted EPS grew by 15.4%.

As in the previous year, in 2009 we achieved all our financial mid to long-term constant currency annual growth targets. The unfavorable impact of the recession on industry volumes meant, however, that we were unable to achieve the 1% organic volume growth target, as we did in 2008.

During the first quarter of this year, we posted strong results and again met, or exceeded, all our mid to long-term currency neutral annual financial growth targets in what remained a difficult economic environment in many parts of the world.

In the first quarter of 2010, our cigarette volume increased by 0.7% to 205 billion units, benefiting from our new business combination in the Philippines. On an organic basis, cigarette volume declined by 2.3%, principally due to significant industry volume erosion in the Baltics, Romania, Turkey and Ukraine. Absent these four markets, organic volume would have grown by 1.2%.

These results are underpinned by the strength and breadth of our brand portfolio, which includes seven of the top fifteen international brands: premium Marlboro and Parliament, mid-price L&M, Philip Morris, Chesterfield and Lark, and low-price Bond Street.

Marlboro is the only truly global cigarette brand. While its international success was initially built in the EU Region, where it commanded an 18% regional market share in the first quarter, over 60% of the brand’s volume is generated in markets outside the Region today. In the first quarter, Marlboro volume was down just 0.6% on a global basis and was up 1.4% excluding Romania and Turkey.

Since the spin, we have significantly strengthened the brand and expanded its reach through the development and roll-out of the new brand architecture.

Net revenues, excluding excise taxes, reached $6.5 billion in the first quarter, up 16.1%, or 6.1% excluding currency and acquisitions. This increase was driven by higher prices across a wide range of markets.

Adjusted OCI, was $2.8 billion, 17.0% above last year’s first quarter, and up by 8.6% excluding currency and acquisitions. Higher leaf prices, which this year are expected to amount to around $200 million, are being largely offset by productivity savings in manufacturing.

Our industry-leading adjusted OCI margin, excluding the impact of currency, grew by 0.4 points in the quarter to 42.7%, with increases in the EU, EEMA and Latin America & Canada Regions. The reduction in the adjusted OCI margin in the Asia Region principally reflects the inclusion in the quarter of 6.1 billion units in the Philippines resulting from our business combination with Fortune Tobacco, which were consolidated and resold with no additional margin.

Adjusted diluted EPS reached 90 cents in the first quarter, a significant increase of 21.6% over the same period in 2009, and up by a very robust 13.5% excluding currency. This quarter, we benefited from currency tailwinds of 6 cents per share, driven by stronger currencies in emerging markets.

Some in the investment community expressed concern that we did not meet the Consensus Estimate of 93 cents for the quarter, as reflected in the stock price decline following the announcement of our results. To argue with Mr. Market can be futile. However, it is important to underscore that the Consensus Estimate appears to have relied on a stronger currency benefit than the one that actually materialized.

Strong earnings growth, strategies to reduce working capital requirements, and tight controls over capital expenditures, have led to a strong expansion in our cash flow. In 2009, our discretionary cash flow, which is defined as operating cash flow less capital expenditures, reached $7.1 billion, an increase of $300 million, or 5%, compared to 2008, despite an unfavorable currency impact of $1.5 billion. Excluding currency, our discretionary cash flow increased by 26%.

In the first quarter of this year, we generated a discretionary cash flow of $1.8 billion, some $500 million, or 42%, ahead of the previous year, and 33% ahead excluding a slightly favorable currency impact. We are just beginning to see the positive impact of our three-year working capital reduction program, which is targeted to generate an additional cumulative $750 million to $1 billion.

Our balance sheet remains very strong with a net debt to EBITDA ratio of 1.34 to 1 at the end of March this year. We have a very favorable debt profile, with over $14 billion in well-laddered bonds in three currencies issued since the spin with an average cost of 5.5%. Our strong liquidity and excellent credit worthiness are reflected in our solid credit ratings, which provide us with significant financial flexibility to pursue strategically compelling and financially attractive acquisitions that will supplement our organic growth.

We continue to implement our strategy to generously return cash to our shareholders. We increased the quarterly dividend by 7.4% in September last year to an annualized rate of $2.32 per share. At the current share price, this represents an attractive yield of 4.8%. We completed our $13 billion, two-year share repurchase program on time last month and we have now started on a new $12 billion, three-year program that strikes an optimal balance between rewarding our shareholders and retaining our financial flexibility.

Since our spin-off in March 2008, we have returned around $20 billion to our shareholders through dividends and share repurchases. This represents over 20% of our current market capitalization.

We estimate that industry volumes decreased by 2.0% last year, with declines in both OECD and non-OECD markets. Given the stubbornly high unemployment levels that prevail in numerous countries and the need for governments to address their budget deficits, we anticipate that industry volumes will again decline this year at a similar rate.

We expect to continue to outperform the industry again this year, as was the case in the first quarter when we gained share in the majority of our key markets.

This share performance is driven by our superior brand portfolio that extends across all price and taste categories. In the first quarter, our international low-price brands performed very well, with strong volume growth for Bond Street, Next and Red & White, as well as local brands such as Delicados in Mexico and Optima in Russia, reflecting the challenging economic situation.

Higher prices continue to be the key driver of our profit growth. Since last October, we have increased prices in nearly all key markets with the exception of Japan and Korea. This drove our favorable pricing variance of $449 million in the first quarter.

Our focus on costs remains rigorous. We are on track to complete the third part of the three-year $1.5 billion cumulative gross cost savings program that we announced in 2008. The $500 million in productivity gains this year will more than offset the forecast $200 million in higher tobacco leaf costs.

Beyond the numbers, we continue to face several potential opportunities and challenges. Let me address five topics that are of interest to our shareholders: the economic recovery, excise taxes, illicit trade, the regulatory environment and business development opportunities.

While our business is economically resilient, it is not immune to economic developments across the world.

We are seeing clear signs of economic recovery across a wide range of markets in Asia and Latin America, such as Indonesia, Korea, the Philippines, Brazil and Mexico. In these markets, consumer purchasing power is growing and demand for premium products is generally strong.

There are also signs of an economic recovery in Eastern Europe, though this has yet to translate into improved employment levels or higher incomes. We are already seeing a slowdown in consumer downtrading and remain optimistic that these markets will start to recover towards the end of this year.

The economic developments across the EU are uneven, with Spain and of course Greece remaining weak with little hope of any immediate improvement. As a result, European consumers generally continue to be very price sensitive.

As governments, particularly in OECD countries, seek to address their budget deficits, they naturally look to tobacco as a potential source of incremental revenues. In general, most governments pursue a policy of reasonable excise tax increases, and excise tax structures continue to improve globally.

The new excise taxation framework, which has been unanimously agreed by the European Union, is a good example of both these points. It calls for reasonable increases through 2018, allows governments to increase the weight of the specific element in excise taxes, and provides them with a more effective Minimum Excise Tax tool to enhance the predictability of their revenue flows.

Each year, however, we do face some significant challenges on the excise tax front and this year we have witnessed abnormal actions in Romania, Turkey, Greece and Australia, with Japan to come in October. Such disruptively large excise tax increases are generally counterproductive. They hurt legitimate industry volumes, spur illicit trade, encourage downtrading and, in most instances, do not generate the anticipated government revenues.

The true size of the global illicit trade – including both contraband and counterfeit – is difficult to estimate for a number of reasons, not least because this is a covert, criminal activity. Illicit trade is a very significant problem in a wide range of geographies, affecting both developed and emerging markets alike. Illicit trade is estimated, for example, to account for about 24% of cigarette consumption in Brazil, 30% in Canada, 23% in Ireland, 37% in Malaysia, 36% in Romania and 35% in Vietnam.

Illicit trade is a growing threat to legitimate business. The threat comes from different sources, the most important of which are counterfeit, and brands with no legitimate distribution in the destination market, a category known as “illicit whites”. I would like to emphasize that, contrary to widespread belief, contraband is not sourced from legitimate duty free businesses. Indeed, more than 96% of cigarettes, appearing to be PMI duty free products and seized by law enforcement agencies in 2008, were in fact counterfeit products.

Illicit trade is an important issue that hurts everyone: the legitimate industry, governments, public health and consumers. It is often the result of misguided fiscal and regulatory policies and is facilitated by weak controls.

We devote significant resources and work closely with governments, customs authorities and other law enforcement agencies to fight illicit trade and close down counterfeit operations. This cooperation has resulted in many successful operations over the years: for example, in the EU alone, more than 30 counterfeiting factories were closed down since we signed our Cooperation Agreement with the EU in 2004. We are also encouraged by the recent efforts by the authorities in both Ontario and Quebec to curtail the sale of illegitimate cigarettes in Canada.

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 website and I encourage you to visit it to learn more about the company’s commitment to addressing the complex issues surrounding tobacco use.

While we support comprehensive, effective and uniform tobacco regulation, we do not support regulation that prevents adults from buying and using tobacco products or that imposes unnecessary impediments to the operation of the legitimate tobacco market.

Specifically, we do not support the growing call for product display bans, plain packaging and bans on the use of all ingredients in tobacco products.

We believe that product display bans impede competition, impose significant costs and other burdens on retailers, encourage adult smokers to make choices based on price rather than product characteristics, and foster illicit trade in tobacco products, as it is much easier to disseminate such products if they do not need to be displayed.

There is no sound evidentiary basis to conclude that plain packaging would lead to a reduction in youth smoking or to any other public health benefit. The UK Department of

Health has in fact stated that “the research evidence into this initiative [plain packaging] is speculative, relying on asking people what they might do in a certain situation.”

In spite of this, on April 29 this year, the Australian government announced that it will seek to introduce legislation that will require all cigarettes to be sold in plain packaging by July 1, 2012.

Plain packaging would be a clear expropriation of our trademarks. It is a misguided measure that we believe would not reduce consumption, smoking incidence or initiation. It would impair free competition, jeopardize freedom of trade, stifle product innovation, and spur illicit trade and counterfeit activity to the detriment of the legitimate industry, its entire supply chain and government revenues. Furthermore, it would violate the terms of international treaties governing the protection of industrial property and the trade-related aspects of intellectual property rights.

Several countries have laws or regulations restricting the use of ingredients in tobacco products that have been in place for many years. These efforts have focused on whether ingredients, when added to cigarettes, increased the toxicity or addictiveness of cigarette smoking. Our products comply with these laws.

However, more recently, tobacco control advocates and some government authorities have been considering regulating cigarette ingredients with the stated objective of reducing the “attractiveness” of cigarette smoking. We oppose regulations that would ban all ingredients because, in light of the millions of smokers in countries like Canada, China or the UK who prefer cigarettes without ingredients, there is no reasonable basis to conclude that an ingredient ban would reduce smoking prevalence.

The potential for growth remains significant, as there is 74% of the world cigarette market, excluding China and the USA, or three in four adult smokers, to still switch to our brands. We expect to further expand our market share both through organic growth and through business development activities.

There are still a number of markets, such as Bangladesh, China, India and Vietnam, where today our presence is extremely limited. Industry volume in these four markets alone reached an estimated combined 2.5 trillion units in 2009, or about 45% of the world cigarette market excluding the USA. We have taken initial steps to develop our business in these markets, but their potential is likely to remain largely untapped in the short to mid-term.

The latest business development project that we successfully completed was in the Philippines. This is an 85 billion unit cigarette market. In terms of price segments, premium already accounts for a sizeable 29% of the market, with mid-price at 18% and low-price 53%. The Philippines is one of the largest menthol markets in the world at over 42 billion units, or half the market.

We have formed a new company that combines the selected assets of Fortune Tobacco and PM Philippines. Together, the market share of these two companies was estimated to have been 92% in 2009 on a pro forma basis. The new joint company is chaired by Mr. Lucio Tan, while management rests with PMI. The integration process is progressing smoothly, with excellent cooperation between the two teams. We expect to start benefiting from synergies in manufacturing, purchasing and sales and distribution as of next year and accordingly we anticipate that this transaction will be mildly accretive to EPS in 2011.

We are confident in our ability over the longer term to grow our business both organically and through acquisitions. Along with higher prices and continued rigorous cost controls, this is expected to drive strong revenue and income growth, which we will leverage further at the EPS level through our share repurchase program.

In conclusion, we expect to continue to deliver against our mid to long-term constant currency annual financial growth targets, as we did in 2008, 2009 and in the first quarter of this year, and therefore to remain an attractive investment for long-term shareholders.

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