奧馳亞 (MO) 2001 Q2 法說會逐字稿

PHILIP MORRIS 2001 SECOND QUARTER EARNINGS CONFERENCE CALL

Good afternoon and welcome to the Philip Morris 2001 second quarter earnings conference call. My name is McKenzie and I am your conference call operator. Today's call is scheduled to last about 1 hour including remarks by Philip Morris and the question and answer session. I will now turn the meeting over to Mr. Nick Rolli, Vice-President of Investor Relations and Financial Communications for Philip Morris.

Good afternoon and thank you for joining us today. For those of you who have access to this call via website, please note you will be in listen-only mode and we encourage you to look at the website while listening to the conference call. Before I introduce our speaker, I have several brief announcements. First, as you know, we issued our second quarter earnings release after the market closed today. If you don't have a copy you can go to the Philip Morris website at www.philipmorris.com, click on the Investor Relations section, and you can get the release. Second, the call will be limited to discussion of our business results for the second quarter of 2001. We will not be covering litigation or regulatory issues. Third, as I believe most of you know, earlier today Kraft Foods announced its second quarter results and hosted a separate conference call. Since the food business was covered in detail on that call, our discussion of Kraft will be limited on this call. Fourth, today's remarks may contain projections of future results and I direct your attention to the safe harbor statement at the end of our news release for review of the various factors that could cause actual results to differ from projections. Finally, media representatives who follow Philip Morris are on the call in a listen-only mode. And now, it is my pleasure to introduce our Senior Vice-President and Chief Financial Officer, Louis Camilleri. Louis?

Thank you Nick and good afternoon everyone. You have all received our earnings release and are now familiar with the details of our second quarter operating results. Accordingly, I intend to restrict my comments to the key highlights of our results and to discuss the factors that drove our performance. Let me turn straight to our second quarter results, which continue the solid momentum we enjoyed in the first quarter. Operating company's income rose 12.4% to $4.6 billion. Currency had an adverse impact of $177 million. Excluding the impact of currency, operating company's income would have been up by 16.7%. Diluted earnings per share of $1.03 was up 8.4% or 8¢ ahead of the prior year. On a constant currency basis, earnings per share would have been up by 13.7%. The 8.4% growth was driven by real business growth of 10.5%, the favorable impact of the reduction in our shares outstanding of 3.2% as a result of our share repurchase program, and 1.1% growth was due to a reduction in our effective tax rate. These factors were partially offset by currency, which reduced earnings per share by 5.3% and the dilutive impact of the 16.1% minority interest in Kraft reduced EPS by 1.1%. I should note that excluding the minority interest the Nabisco acquisition was essentially breakeven and therefore not diluted already in the second quarter, which we are very pleased by.

Let me now turn to the performance of our individual operating companies starting with Philip Morris, USA, our domestic tobacco company. Philip Morris, USA, had another very strong quarter. Volume at 53.7 billion units was flat versus prior year. Shipment share was up 0.9 percentage points to 50.8% and operating company's income surged 8.6% to $1.4 billion. Recently, there have been some questions related to the domestic tobacco industry and accordingly, I would like to take this opportunity to address those questions. First and foremost, we have said for sometime now that Philip Morris, USA, strives to reach an optimal balance between share growth and profit growth, and I would dare say that Mike and his team have consistently achieved that goal quarter after quarter and year after year. It is undeniable that there has been a significant intensity in the level of promotional pricing and the incidence of free product offers since the fourth quarter of 2000. Philip Morris, USA's, total retail share as measured by IRI Capstone was essentially flat in the quarter. It was actually down less than 0.1 percentage point. But, this measure alone marked a number of key developments. Our key brands, the four key brands we support, Marlboro, Virginia Slims, Parliament, and Basic, all performed strongly at retail with an aggregate share gain of 0.9 percentage points led by Marlboro with a gain of 0.6 percentage points. In addition, very importantly, PM USA share of the premium segment at retail grew 0.4 percentage points to 61.6%.

This again was fueled by Marlboro, which gained a full share point within the premium segment. Another important factor is our performance within trade channels. We sustained our strong momentum within the crucial convenience store channel. Share was up 0.7 percentage points to 54.5%. We performed strongly in other trade classes, however, we did lose share in the tobacco discount channel. Our share here was down 2.1 percentage points to 33.1%. We are not unduly concerned by this phenomenon. Tobacco discount stores attract consumers that have an older age profile and where brand loyalty is weak. Price is the predominant decision factor. Very importantly, the premium segment was a 73.7% share of the industry of retail continues to exhibit strong resilience. Although, it was marginally down 0.2 percentage points versus prior year at retail, it was actually up versus the first quarter by 0.1 percentage points. Finally, we estimate that wholesaler's inventories of our products decreased some 200 million units from the first quarter, that is a decrease of 200 million units and a decrease of some 400 million units versus the prior year period. I should also add that that decrease we estimate represents about two-thirds of the total industry inventory reduction. So, there you have it, PM USA's fundamental strengths remain intact, and we remain optimistic that we can continue to strike that balance between attractive profit growth and moderate share growth that has proved so elusive to others in the industry.

Turning now to our international tobacco business. Philip Morris International operating company's income increased 2.9% to $1.3 billion driven by increased volume and higher pricing. Excluding the unfavorable currency impact of a $151 million, operating company's income would have increased by 14.4%. Shipment volume increased 4.2% to a 179.9 billion units reflecting good growth overall, offset by weakness in Germany, Turkey, and Argentina. Let me address these 3 markets. In Germany, where the volume was down 6.8%, we have started to see sequential stability in our market share in the last few months. Trade brands appear to be losing some of their steam and the vending segment, as we had projected some time ago, is beginning to grow modestly. So, the signs there are we're seeing stability and slight improvements in the fundamentals. In Turkey, volume was down due to consumer [downtrading] to low-priced brands as a result of 3 consecutive price increases following the devaluation of the Turkish lira in February. In fact, the retail price of Marlboro increased by some 50% in the space of 2-1/2 months. Since then we have launched Lark in the below-premium segment in June and early indications are positive. We have also repositioned L&M in the mid price segments. In Argentina, volume was lower due to weak economic conditions, but we did see a strong share increase on the performance of the Philip Morris brand, which is now the #2 brand in the country behind Marlboro and overtaking Jockey

Club of BAT. Overall, our share increased in most of our top 25 income markets with gains of 1 point or more in 15 markets including Argentina, France, Japan, Korea, Malaysia, Mexico, Russia, and Ukraine. These gains were fueled primarily by the sustained momentum of Marlboro. In Western Europe volume rose 1.8% with strong gains in France, Spain, and Portugal. Again excluding Germany, volume would have been up 4.3%. In Eastern Europe, volume rose a very strong 18.9% led by increases in the Baltic, Russia, and Ukraine. In central Europe, Middle East and Africa, volume declined by 1.1% with strong increases in Romania and Saudi Arabia offset by Turkey. Again here excluding Turkey [_______________] a volume increased 4.3%. In Asia volume increased a strong 9.8% with particularly strong gains in Japan, Indonesia, and Korea. In Japan share rose to a record 22.5% driven by the continued strong performance of Marlboro and the launch of Lark One in May of this year. In Latin America volume was up 2% driven by strong increases in Mexico. Let me now turn to our food business. As mentioned earlier Kraft Foods reported its results separately this morning. So I will touch only on the highlights of their performance. Kraft Foods had a strong quarter both in North America and internationally. Total Kraft Foods volume increased 3.4% on a pro forma basis. Kraft Foods North America volume was up 2.8%, while Kraft

Foods international volume was up 4.9%. Pro forma operating company's income was up 7.4% and excluding an unfavorable currency impact of $29 million, income would have been up by 9.3%. Turning now to our beer business, Miller Brewing company's performance was soft in the second quarter, but we are seeing modest signs of improvement in key business fundamentals, specifically we have witnessed a sequential improvement in both volume and share for our 5 core brands namely, Miller Lite, Miller Genuine Draft, Miller High Life and Fosters, and ICEHOUSE, and in fact Miller High Life and Fosters are increasing in volume. There 5 brands account for 75% of our volume and this improvement is behind improved execution and advertising effectiveness. Looking ahead as a result of the continued strength of the US dollar we now expect full year underlying diluted earnings per share growth of approximately 9%. A further strengthening of the US dollar versus foreign currencies and other factors mentioned in our press release represent continuing risks to this projection. In summary, we had a strong second quarter. Our domestic tobacco business delivered solid gains across the board and is well positioned for additional income and share gains. Our international tobacco business delivered a solid income gain despite unfavorable currency, and sustained good volume growth worldwide. Our worldwide food business performed well with gains and volume and income driven by

new products and Nabisco. While our beer business continues to face challenges the strategic actions that have been taken by John and his team are showing early signs of working. Finally and importantly I want to remind you that during the second quarter we continued delivering on our commitment to improve shareholder value through our share repurchase program. Repurchasing 20.3 million shares of common stock at a cost of $1 billion. This concludes my introductory remarks and now I will be happy to take your questions.

Ladies and gentleman we will now conduct the question and answer portion of the conference. In order to ask a question please press the "1" key followed by "4" on your touchtone phone. Our first question is coming from Bill Pecoriello of Sanford C. Bernstein & Co., please go ahead sir.

Good afternoon Louis, how are you?

Very well thank you, how are you Bill?

Good, my questions are on the domestic tobacco business, the stepped up promotional expense that you had announced for the second half, was that a reaction to the deceleration in your overall premium share despite the growth in the core brands, was my first question, and than the use of the free goods, you talked about you actually deloaded inventory in the second quarter but your shipment shares are up 0.9, your retail shares are flat, so is that due to the math of what you are lapping on retail volume growth or is the shipment why you build share and it looks like an inventory build but really isn't and then the last part is the 30% growth that we are seeing in the low price discount brands, when does that concern you, was is it only if the premium segment begins to slip and if that does not happen the increasing price gap on the growth of these brands don't concern you?

Okay three questions in all. The increase in our promotion, was it directly a reaction of our share? I would say no, it is something that was planned sometime ago, Bill. You'll note that we have essentially stayed in a pretty narrow band in terms of our price promotions versus the retail price and that band has been between 14% and 16% of the last 3 years and we remain in that band with the 60 cents, so we are not concerned by the retail performance, as I said I think the retail performance was pretty strong, and we continue to look at the future quite positively. In terms of the second question which related to the finished goods, you'll note that actually in this quarter, the shipment share and the retail share are actually about the same, so what you are seeing is what you talked about in terms of overlapping quarters-to-quarters and you'll always see a bit of difference between shipment share and retail share but in this specific quarter, the shares are actually smack on. With regard to the discount brands, all others at retail are about 6.9%, that is up about 0.3, 0.2, 0.3 versus the first quarter, up 1.1% versus the last year and we are seeing a sort of slowdown in the growth, as you mentioned very importantly we see that the premium segment continues to be very resilient and that is something that we are very focused on and these all other manufacturers have actually gained share within the discount segment. I am not mistaken they now represent about a quarter of the discount segment and they are really, at this point, essentially gaining share solely within the discount segment and premium is remaining very resilient which is very important to us.

Thank you.

You're welcome.

Thank you, our next question comes from Bonnie Herzog of Credit Suisse First Boston, please go ahead ma'am.

Hi, Louis

Hi Bonnie.

I have a follow on question to Bill's last question related to the, I guess the settlement payments that will be decreasing in the next few years. If you look out into 2003, the [_______________] should decrease substantially, so, do you see some of these smaller fourth tier, other companies possibly going out of business or for instance, do you expect the price gap to narrow substantially, in other words, do you see this trend reversing itself in the next couple of years.

I would hate to speculate on what is going to happen in 2003, Bonnie, all I would say is that we feel pretty good about the fundamentals of our business and the additional income that should flow through because of reduced MSA payments in 2003, will clearly give us added flexibility. So that's a further plus going forward. I wouldn't want to speculate what on others may or may not do.

Okay, fair, and than in terms of your margin at PM USA, you have addressed the issue with the increased promotional spending, the good thing is you are able to increase volumes or I should say kick share, and than increase your income, but I guess when you look at your operating margins they seem to be deteriorating, do you expect to see that reverse itself in the next couple of years or anytime soon.

Well, let me address what you are saying in terms of deterioration. That is a function, a bit of the MSA payments and also partly because of increased marketing in terms of the promotions. I think Mike [_______________] and his team have done a great job at actually improving real margins, also addressing cost because they have great programs in terms of reducing cost as well as the fact that we are seeing improvements in our mix, so I would say that you also have to focus on what is happening on the cost as well as on the mix side.

And as you said earlier this is the share gain, and if you continue to take share, long-term this should work itself through.

The key is the balance. You need attractive profit growth and share. You can't have one or the other.

Louis, can you give us an idea of what percent of your total volume was promoted during the quarter? And then may be how this compares with some of your competitors, if you have a feel for that?

I have a very precise feel for it but I am not sure I want to disclose that number. All I can say, for your benefit Bonnie, is that clearly our promoted volume as a percent of our total volume was much lower than that of our competitors.

Okay, one last question. What are your thoughts on the Internet? Could you foresee, starting to sell on line especially that, given we are probably moving into a more restricted marketing environment in the next couple of years, what are your thoughts or strategy related to the Internet?

Well I think that there the main issue is access and youth access. And until such time that there is a foolproof system to ensure that youth will not have access to cigarette shipments through the Internet, certainly this company will have nothing to do with the Internet.

But is it safe to assume if you felt comfortable there was some type of technology out there?

Oh, we haven't seen that yet Bonnie.

All right. Thank you so much Louis.

Welcome.

Thank-you. The next question comes from Martin Feldman of Salomon Smith Barney. Please go ahead, Sir.

Thank-you. Good afternoon Louis.

Good afternoon Martin.

Louis, can we switch to talking about international for a moment? I just wanted to, you have made this, given this new guidance of 9% EPS growth for the year, what is your currency assumption on that basis? What are you assuming for the remainder of the year in terms of the euro and perhaps the yen?

Well, Martin, we are estimating a currency hit for the full year of $500 to $520 million. Year to date, if you take the first quarter of a $106 million, the second quarter of a 177, that is 283, so the balance in the second half is slightly less than the first half and that is essentially because the euro, you will recall, in the second half of last year was slightly weaker.

Exactly.

It is still average 92 and we are below that number. But we are also seeing weakness in other Asian currencies and in Central and Eastern Europe that we did not have last year.

Can you give...

In a nutshell, for the year, the full year impact at this stage is $500 to $520 million.

Okay, now, I understand what you are saying but just, could you give us an idea of the sensitivity, if the dollar was to begin to weaken and we went back to 90¢ to the euro or 92¢, what would that do to the full cost besides pushing it up a little?

Martin, we have never really divulged our currency, what 1¢ euro does in terms of profitability and I am not prepared to do that at this stage.

Okay.

We will see how things unfold during the year. At this stage, the euro has strengthened a bit in the last 10 days.

Right.

We will see what happens, I know there is lot of uncertainties specifically in terms of Argentina and Turkey. I am heartened by the fact that I read a report yesterday that the IMF felt that Argentina should manage to pay its debts without defaulting, so that is a good sign. We will see how things unravel. They are only just speculations.

Alright. From the reported currency point of view obviously you have addressed that on Argentina, but simply from the weak economy, how much is your business being hurt or has been hurt in the second quarter, in the last perhaps few weeks especially by what is going on there?

In Argentina, as I mentioned Martin, our volume in the second quarter was down about 5%. That reflects market contraction. Our share was actually up and [_______________] was sort of projecting flattish volume because in the first quarter volume was up. We are projecting flattish volume for the year, strong share, and income should be quite significant because there has been an actual reduction in excise taxes to try to increase consumption of legal products because there is quite a lot of product coming into Argentina in the form of contraband.

Right, right, right. Thanks for that, Louis. Just moving on to the domestic business. Clearly, you had a very strong performance in premium, in terms of your premium versus the market, your premium up 1.6 versus the market down almost 1%, but in discounts, I am not sure that, I mean I estimate that your discount volumes were down about 11%. Is that a reasonably accurate number?

But, I don't have the number in front of me Martin. Discount was down, but very importantly, Basic held share and you will recall that Basic actually sells as a premium to the other discount brands, and we are very pleased to see that Basic held share and where we lost share in the discount segment was on Cambridge and private label. We are not unduly concerned by that. We are also facing a difficult comparison because if I recall at this time last year we had revamped the Cambridge brand.

Okay, okay. Clearly we have seen that there has been a lot of remarking about the level of discounting in the market and [_______________] actions in the market. Is there any way to, when you look at your share, on a weekly basis, or you look at your share on a far more detailed basis than perhaps we see it, if you look at your shares in a period in which there is no promotional activity by any of the big four manufacturers, how does your share compare to the way it is on a quarterly basis, one of the long period where you, for example, have had RJR discounting quite heavily and pushing free volume into the market?

It is very difficult to find a period Martin as you suggest when nobody is on promotion. This varies the whole time. And some of our competitors are actually on permanent promotion. So, it is difficult to find that period. But clearly one could estimate that with promotion levels reducing, that could only benefit us. And that is natural because of the equity of our brands.

Right, right, right. Last question, you have lowered your numbers a little bit to 9% growth this year and you have essentially said that that's all is a result of currency. Essentially you are leaving intact, the guidance you gave at the beginning of this year for profitability of PM USA, and essentially, I think you are saying that you are not, that there is no reason to be adjusting to your formal estimates for the year on PM USA?

That is absolutely correct. In fact, PM USA is performing better than we had anticipated, and when we gave our guidance of 9 to 11%, we had always warned people that currency was a concern. Regretfully that concern materialized as the months unfolded.

Right, right.

Hopefully, one day, that will turn around.

Let me ask you a question, this is probably unfair, but see if you have got any reaction anyway. RJR clearly has its cash from [_______________], it just came in at the end of last year, it has got one year's worth of EPS growth without having any real tobacco growth because of that growing interest income. Starting January 1, 2002, it is lapping a tough comparison. Do you think that means that the level of discounting we may see from that company reduces?

I can't comment on that Martin, you have to ask them.

Okay. I will do that tomorrow. Thanks for your help, Louis.

Okay, bye.

Bye.

Thank-you. The next question comes from David Adelman of Morgan Stanley. Please go ahead, Sir.

Hi Louis.

Hi David, how are you?

I'm good and you?

Okay. Pretty good.

Good. Do you have any pricing gap information in front of you in the second quarter for what the average Marlboro price is? The average price of Marlboro versus the lowest discount brand?

Yeah, I do have that actually. It was essentially, Marlboro was at about 328 at the end of the quarter and the gap was 92¢ or 39%.

Okay.

Now that varied a bit week-to-week, but that was a sort of the end of the quarter.

Okay, second question on the non-big four manufacturers. At best you can tell, Louis, are they making settlement payments? Are they accruing for that in their prices in the marketplace? Or are they just going out of business when it comes time to make their payment?

I am not sure, we know for fact [_______________] Scientific is not because they are not party to the agreement. Commonwealth must be, given their shares, but I can't tell you the other small manufacturers, David.

Okay, and then one last thing, Louis, on the UK, subsequent to prevailing in the litigation to remove Marlboro from the joint venture agreement. When are you going to disclose publicly what your go-to-market strategy in the UK is going to be on that brand? And what is the precise timing? Did you give notice last September, so would it be this September that you have the right to change Marlboro in the UK?

In terms of the notice period that is correct, David. We will hopefully announce that within the coming few weeks as to what exactly we will do. I am not prepared to go beyond that.

Okay.

You'll understand.

Sure. Okay, thank you very much.

You're welcome.

Thank-you. The next question comes from Ann Gurkin of Davenport. Please go ahead, Ma'am.

Hi Louis.

Hi Ann.

Just to get back to the promotional activity in the US, and you just mentioned they are [_______________] about running a balance between share versus margins on domestic tobacco. But are we seeing more of a shift towards the market share going after market share rather than running a balance between margins and market share?

Certainly not in this company. As the income numbers have shown over the last couple of years.

Okay, and then can you give me your projections for the growth of the American blend cigarettes, outside of the US?

Internationally, we still see it growing between 2% and 3%, Ann.

And how about for the next year, 2002?

We see that sort of staying between 2% and 3%. We see no reason why that would change.

Great. And also can you update me on how the tests are going with paper select on the Merit brands?

It's going quite well. I don't have any specific details. All I know is that it is an extended test. Originally, it was on 1 or 2 variants, it's now on all of Merit and learning from that and the indications are that everything seems to be doing quite well.

Great. Thanks Louis.

You're welcome. Bye Anne.

Thank-you. The next question comes from James Borges of First Union Securities. Please go ahead, Sir.

Hi, I thought I'd ask a little bigger picture question. Could you talk a little bit about China and what you see the developments there as far as that market opening up further and any initiatives you have on that front?

Well, China has always been somewhat seen as an El Dorado by all consumer product companies.

Right.

In fact we actually did quite well there in food, and we're one of the rare companies who are profitable and are actually generating free cash in China. Having said that, the tobacco industry, as you know, is controlled by a monopoly. There have been some small international joint ventures. That volume is capped to insignificant levels, and we believe that the monopoly going forward will maintain a stranglehold on the market. I know that one of our major competitors recently announced that they had an agreement with the monopoly and the central governments. The monopoly, a few weeks later, denied that such an agreement existed. So, I don't know what the truth is. We have worked diligently over the years and we continue to pursue whatever opportunity, but I believe it's going to take some time. Clearly with WTO entry it may help, but we believe it's going to take time to penetrate that market, James.

Okay. Thank-you. And how about trends towards American [_____________] cigarettes in countries like Indonesia or India? Anything different there from your overall outlook of 2% to 3%?

No, we see a general trend towards American blends worldwide, even in markets that have predominantly been Virginia markets. The Middle East is a great example. If you go back 25-30 years ago, the Middle East was all Virginia brands. Today, American blend is by far the predominant segments, and in fact, in markets such as Saudi Arabia, we have a share of about 68%, if I recall. So, you are seeing that shift even in the UK, the only premium brand that is growing is Marlboro. So, we're seeing that shift basically worldwide into American blends. We are still pretty confident about our 2% to 3% growth rate going forward.

And finally, specifically on Germany, what were industry volume changes in the quarter?

Total volume was actually slightly down for the quarter. I believe there was one less trading day during the quarter in Germany that was slightly down. But the issue there is, as we have said in previous discussions, the issue there is really the trade brands which have grown significantly, although we have seen them flattening out in recent months and the vending segment was declined significantly, which is now starting to pickup. We lost year-to-year more than one share point in Germany, since March our share has actually been flat, just very, very slightly up.

Okay Louis, thanks for the call.

You're welcome, James.

Thank-you. Our next question comes from [_______________] Alexander of [_______________] Associates. Please go ahead, Sir.

Pass. It has been answered. Thank-you.

Thank-you. Our next question comes from Rob Medway of Royal Capital. Please go ahead, Sir.

My question has already been answered. Thank-you.

Thank-you. Our final question comes form Bonnie Herzog of Credit Suisse First Boston. Please go ahead, Ma'am.

Thanks. Louis, I just had a followup question. Can you tell us when you are going to start publishing your US volume by brand again? The breakdown you used to give us?.

Well, we have decided we are not going to do that Bonnie, any more for competitive and other reasons.

Alright. And then can you give us some guidance on interest expense and minority interest income going forward?

Well. Minority interest was slightly impacted in the second quarter because of Kraft. As you know 16.1% of Kraft is now in public hands and clearly that is going to impact the second half. If you listen to their comments this morning and take 16.1% of their projected earnings for the year, you should be able to do on minority interest.

Okay. And then what about interest expense? You're net interest...

Expense, this second quarter was probably the higher quarter because we only got the benefit of the IPO in the last couple of weeks. Also going forward you should see better interest.

But you do not feel comfortable giving me a range?

No.

Okay. And then unallocated corporate expense was down as in the quarter, is that...

Well, we've made quite a significant effort at corporate to reduce expenses and you are seeing that. It was probably, part of it is timing, I don't think it will come down that much during the year. It will come down but not as much as in the second quarter.

Okay. Thanks Louis, I appreciate it.

You're welcome.

Okay. That's all at this time we have scheduled for this call. We appreciate you joining us this afternoon and we look forward to talk with you again next quarter, and we will be sending out a notice in early October with the date and filing information for the 2001 the Philip Morris third quarter conference call. Again, thank you very much. Have a good day.

Bye everyone, thank-you.

Thank-you. This does conclude today's Philip Morris teleconference. You may disconnect your lines at this time and have a wonderful day.

Bye. Thank You.