Market Overreacts to Philip Morris, Shares Attractive

Our long-standing thesis on wide-moat

Two issues stand out from PMI's first-quarter results. First, the company missed volume expectations, reporting a total tobacco volume decline of 2.3%, versus consensus estimates of flat in the quarter and our full-year assumption of a decline of 1.3%. With combustibles in line with expectations, the miss was caused by a significant shortfall in Heatsticks shipments in Japan, which we believe was driven by a pullback in shipments in order to rightsize channel inventory.

Second, a boost from a lower effective tax rate, now being guided to 26%, down from 28%, is not filtering down to earnings in full. We assume 26% to be the ongoing tax rate, but that the customer acquisition cost in the emerging tobacco categories may be higher than originally thought. We have lowered our medium-term margin forecast by around 90 basis points to account for heavier investment behind customer acquisition, and we have increased our estimate of PMI's investment rate in stage II of our model to 14%, to be more consistent with companies in more competitive consumer staples categories.

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