Introduction
Philip Morris (Pakistan) Limited (PSX: PMPK) is among the two major tobacco firms operating in the formal sector, along with Pakistan Tobacco Company Limited (PSX: PAKT). PMPK traces its operation's origin in Pakistan to about fifty yeas. The company is involved in the manufacturing and sale of cigarettes and tobacco products. PMPK is an affiliate of the Philip Morris International Inc. (PMI) company.
Roughly a decade back, the PMI global had formally entered Pakistan after acquiring a local tobacco firm, Lakson Tobacco. Philip Morris Investments B.V. (incorporated in the Netherlands) is PMPK's holding company, with a 77.65 percent stake as of December end 2018. Philip Morris Brands SARL is the PMPK's associate company, which holds 20 percent shares in the firm. Latest pattern of PMPK's ordinary shareholding is provided below:
PMPK operations
The company had three operational facilities as of 2018. It had one tobacco-leaf threshing plant in Mardan, Khyber Pakhtunkhwa, besides two cigarette-manufacturing facilities, one each in Sahiwal, Punjab and Kotri, Sindh. In March 2019, PMPK informed its shareholders that it was in the process of closing down its Kotri factory to streamline its manufacturing footprint in accordance with the market trend. This follows a similar measure in 2015 when PMPK closed its Mandra factory in Punjab.
Just as PAKT, PMPK also holds a diversified product portfolio. Its brands include high-end brands (e.g. Marlboro), medium-end brands (e.g. Morven Gold) and low-end brands (e.g. Diplomat). The firm has historically commanded a fifth of the tobacco market by volume (cigarette sticks).
Recent financial performance
Financial performance at PMPK is a matter of top-line growth, as this firm is operating in a highly-regulated market. In recent years, the rise and fall, and then rise, in the fortunes of PMPK have been highly correlated with the broader market. The formal tobacco industry - which is almost completely dominated by PAKT and PMPK - has been under the cloud of illicit cigarette sales in the country. Most of those illicit cigarettes are said to be duty-non-paid (DNP) cigarettes, which are being assembled locally but fall through the regulatory cracks to avoid the taxes and duties that are due on production and distribution of cigarettes. This creates a price gap between the formal sector and DNP sector, to the latter's advantage.
PMPK saw its gross turnover stagnate around Rs40 billion in CY15 & CY16. The following year came a major fall in revenues. Faced with declining volumes around 2HCY16 and 1HCY17, PMPK, like its counterpart, started raising concerns about threat from DNP cigarettes, which had commanded, by one estimate, about a third of the market by that point.
The government, alarmed at losing its hitherto-assured tobacco billions, responded by introducing a third tier for FED in May 2017. That tier carried a nominal FED in the value-for-money segment. It has helped formal sector narrow the price gap and take back the market share from the duty-evading informal sector.
Not only have PMPK's sales have gone up in the nearly two years since the three-tier FED system was introduced, the event has also helped the firm retain more of its gross sales. For instance, in the two years prior to launch of the third FED tier, PMPK retained, on average, 36 percent of its gross turnover as net turnover. In the two years after that fiscal intervention, PMPK retained an average of 46 percent as net turnover.
This significantly higher retention, on top of top-line growth making a comeback, is a good omen for the firm's financial health going forward. One can see visible improvement in financials in the first full calendar year (CY18) since the third tier was applied.
Operationally, in terms of gross turnover, PMPK's income statement is presenting a better picture compared to years gone by earlier this decade. However, the cost of goods sold - which came in at 28 percent of gross turnover and 63 percent of net turnover in CY18 - needs to be further reined in. However, the marketing expenses and administrative expenses - collectively consuming 14 percent of gross turnover and 31 percent of net turnover - are holding steady in the face of tough operating environment.
In the end, despite the top-line gain in CY18 along with a lower income tax bill, PMPK's net profits, which more than doubled on a year-on-year basis, couldn't eclipse the decade-high figure attained in CY16. That was thanks mainly to higher distribution expenses and exchange losses last year.
Stock performance
Over at the bourse, the PMPK scrip is a thinly-traded share due to just 5 percent free float out of 61.58 million shares. However, in the last 52-week period, the stock, which doesn't move with the broader market (it has a negative beta), has appreciated nearly 50 percent. The stock stood at Rs4,000 per share as on April 10, 2019.
Outlook
The upcoming budget will spell which way the tobacco industry's fortunes go in the short-term. Despite health advocates' alarm at rising cigarette sales at cheaper prices, the government seems to be in favour of continuation of the multi-tier tobacco FED regime because this system has helped the tobaccos contain the DNP market and set the government's tobacco billions back to growth in CY18.
However, it remains to be seen what percentage the budget will recommend in terms of FED hike on the third tier, as FED hike is almost a norm for tobaccos during budget season. If the FED increase in double digits, it will make the third tier price-uncompetitive as price gap further widens with the DNP brands, a la 2016 and 2017. However, an inflation-adjusted increase may suit the tobacco industry fine.
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PMPK: Pattern of shareholding No. of Shares % of total
(ordinary shares) (as at December 31, 2018) shareholders held shares
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Directors, CEO and their spouse and minor children 7 76 0.00%
Associated companies, undertakings and related parties 2 60,135,410 97.65%
Philip Morris Investments B.V. 47,819,350 77.65%
Philip Morris Brands SARL 12,316,060 20.00%
Investment Corporation of Pakistan 1 58 0.00%
Commercial banks 2 3,360 0.01%
Pakistan Reinsurance Company Limited 1 10,620 0.02%
CDC-Trustee AKD Index Tracker Fund 1 680 0.00%
General public (local) Not available 702,700 1.14%
Others Not available 727,411 1.18%
Total 61,580,315 100%
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Source: Company accounts
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PMPK: Financial snapshot
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Rs (mn) CY18 CY17 CY16 CY15 CY14 CY13 CY12 CY11
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Financial position
Share capital-ordinary shares 616 616 616 616 616 616 616 616
Share capital-preference shares 10,464 10,464 10,464 - - - - -
Shareholders' equity 12,611 12,901 13,590 2,649 3,989 5,494 5,953 6,563
Fixed assets-net 7,348 7,819 8,517 8,048 7,417 6,903 5,390 3,946
Working capital 4,552 4,358 4,272 -6,374 -3,992 -1,830 515 2,781
Operating results
Net turnover 16,200 13,967 14,213 14,417 13,764 13,728 13,551 12,217
Gross profit 6,024 5,078 6,021 4,855 3,911 3,668 3,813 2,698
Operating profit/loss 640 565 1,133 -894 -909 -530 -160 -92
Profit/loss after tax 543 191 575 -1,315 -1,482 -441 -574 -442
Financial ratios (based on net turnover)
Gross margin 37% 36% 42% 34% 28% 27% 28% 22%
Operating margin 4% 4% 8% -6% -7% -4% -1% -1%
Net margin 3% 1% 4% -9% -11% -3% -4% -4%
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