Venture Corporation - UOB Kay Hian 2018-10-02: Philip Morris Investor Day Slides Offer Glimmer Of A Better 2019

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VENTURE CORPORATION LIMITED SGX:V03

Venture Corporation - Philip Morris Investor Day Slides Offer Glimmer Of A Better 2019

• Takeaways from Philip Morris Investor Day showed that IQOS device sales are picking up.
• Conversely, share of market growth in key markets Japan and Korea are flat or declining. The next-generation IQOS 3 sees two models being released and we are concerned about cannibalisation. Production in 2019 could be higher than currently projected, but the split remains difficult to gauge.
• No change to our earnings forecasts for now. Maintain HOLD and target price of S$18.20. Entry price: S$16.00.

WHAT’S NEW

• Takeaways from Philip Morris International’s (PMI) Investor Day 2018 last week:

IQOS kit/holder sales are picking up again.

• Philip Morris International (PMI) made a rare disclosure of actual unit sales of IQOS in Japan from Apr 18 to Aug 18. In 2Q18, approximately 1.8m IQOS kits/holders were sold, while for the first two months of 3Q18, 1.7m units were sold. 
• Recall in Jun 18, PMI had slashed prices for its IQOS kits by 30% to ¥7,980/unit, which could have helped sales.

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PMI shows IQOS user base to be larger than previously assumed.

• Previously reported figures only disclosed https://sginvestors.io fully converted users, which represented 70% of total users that purchase an IQOS device. As of Aug 18, total users stood at 8.6m (2017: 6.9m), with fully converted users at 5.8m (2017: 4.7m). The proportion of fully converted users is consistent with Philip Morris International (PMI)’s remarks made at its Nov 17 Morgan Stanley Conference.

Growth in East Asian markets slowing.

• Share of market for the key Japan market declined to 15.2% as of end-Aug 18 (2Q18: 15.5%). IQOS conversion rates were also down to 58% in Aug 18 (Sep 17: 65%).
• South Korea, which could have potentially offset the slowdown in Japan, saw its share of market increase slightly to 8.1% as of Aug 18 (2Q18: 8.0%). Conversion rate in South Korea has also fallen to 59% in Aug 18 (Sep17: 66%).

Europe picked up the Asian slack.

• Partially offsetting this is a https://sginvestors.io pick-up in European countries Italy, Greece and Russia, which saw their share of market increase by 0.4- 3.1ppt vs 1Q18 figures (2Q18 data was not available).

PMI net revenue growth guidance shifted to lower end.

• At the start of the year, Philip Morris International had guided net revenue growth (ex-currency) at 8%. After the setback in Japan, guidance was shifted to 3-4% in its 2Q18 results. The latest https://sginvestors.io deck shows guidance at ~3%.
• IQOS devices were guided to account for 20% of RRP net revenue; this is low as historical figures have trended at 22-25% of RRP net revenues in 2016-17.

Not one but two IQOS 3 products launching.

• The next generation of IQOS sees two models - IQOS 3 and IQOS 3 MULTI. The launch of two separate product lines ties in with channel checks earlier in April that Venture Corporation (Venture) and FLEX were separately pursuing their own next generation IQOS designs.

Philip Morris International (PMI) reports its 3Q18 results on 18 Oct 18 at 9am Eastern Time (9pm Singapore Time).

STOCK IMPACT

Volume pick-up in 3Q18 points to an encouraging 2019.

• Assuming IQOS device sales continue to pick up at the rate seen in 3Q18, it suggests that demand remains robust despite the falling share of market in Japan. With the launch of the next generation IQOS device, this could spur replacement demand and translate to a pick-up in IQOS 3 production volumes in 2019.
• Greater clarity on this will probably emerge closer in end-18.

Device sales outpaced user base growth.

• Device sales of 1.8m in Japan alone outpaced global user growth of 0.6m, showing that using user growth to gauge device sales results in a gross underestimate. Extrapolating the latest data and comparing against Philip Morris’ rule of thumb for device to heated tobacco unit (HTU) sales (330,000 - 350,000 devices per incremental billions of HTU shipped) yields a fairly consistent set of device sales figures.
• Taking an assumption for inventory allowance, it is highly likely that average monthly production in 2017 was well over 1m units/month. Venture was the sole producer in 2017; FLEX’s inventories only reached market in 1Q18 based on our channel checks.

Presence of IQOS 3 Multi a concern.

• The emergence of a design variant in the IQOS 3 product line-up worries us as it verifies our earlier channel checks that FLEX was building a competing design. The design differences between both are unclear at present.
• With both producers likely building their own respective designs, there runs a risk that one may cannibalise demand for the other, thereby edging the other manufacturer out and taking market share from them. This could work both ways for Venture.

EARNINGS REVISION/RISK

No change to 2018-20 earnings estimates for now.

• Our estimates have not taken into account the new IQOS 3 production schedule.
• For 2018, factoring it in will result in a 1- 3% increase in earnings. For 2019-20, our estimates for IQOS production may be on the low side and we will revise when visibility emerges. For the rest of the segments, our growth assumptions are unchanged.

VALUATION/RECOMMENDATION

• Maintain HOLD and target price of S$18.20, pegged to 14x 2018F PE.
• Upside risk could stem from a higher-than-expected production schedule for IQOS 3 in 2019, which will significantly lift earnings https://sginvestors.io. Until that clarity emerges, maintain HOLD.
• Entry price is 16.00.

Foo Zhi Wei UOB Kay Hian Research | https://research.uobkayhian.com/ 2018-10-02

SGX Stock Analyst Report HOLD Maintain HOLD 18.200 Same 18.200