VENTURE CORPORATION LIMITED (SGX:V03)
Venture Corporation (VMS) - Takeaways For Venture From PMI’s 3Q18 Results Announcement
- Philip Morris International (PMI)’s 3Q18 results show that demand for IQOS remains stable. Growth is slowing in key market Japan and is hinged on Europe.
- Despite the outlook, the production outlook for Venture Corp is less rosy as we expect initial production for the next generation IQOS to be smaller. The IQOS 3 Multi design, likely exclusive to FLEX, is potentially detrimental to Venture Corp owing to its superior design.
- Maintain HOLD with unchanged target price of S$18.20. Entry price: S$15.50.
WHAT’S NEW
- Philip Morris International (PMI) announced its 3Q18 results last Thursday. Key takeaways are as follows:
HTU in-market sales continue to grow in Japan.
- While heated tobacco units (HTU or Heatsticks) saw shipments decline 11% y-o-y, with the decline in Japan being exceptionally steep at -48% y-o-y in 3Q18, in-market sales remained healthy. Implied in-market sales continued to grow, coming in at 7.5b units (+45% y-o-y, +13% q-o-q). The decline in Japanese shipping was due to PMI drawing down on inventories from over-shipping in prior quarters.
- With inventories right-sized, PMI expects HTU shipments into Japan to improve by 0.3b units in 4Q18.
Device sales stable despite making up 14% of 3Q18 net reduced risk product (RRP) revenues.
- There are two dynamics at play here:
- PMI is selling kits at the discounted price to all users regardless of whether it is a first-time purchase,
- the holders are being sold separately, and given the lower growth of new users, the sales mix of holders/kits should be skewed towards holders. This was already apparent in the Investor Day slides in Sep 18, which highlighted that holder sales saw larger growth than kits sales.
- Additionally, device sales for the first two months of 3Q18 in Japan were at 1.7m units, comparable to the 2Q18 sales figure of 1.8m units. Therefore, one should not read too much into the lower proportion.
No update on FDA approvals.
- Management said that they remained hopeful of hearing from the FDA by end-18. Otherwise, the situation remains largely unchanged with the US launch still up in the air.
IQOS 3 and IQOS 3 Multi to be launched in 4Q18.
- PMI expects the launch of the new design to revive device sales, with sources suggesting a launch in mid Nov. Production is being ramped up, and we note that PMI seemed particularly more excited about the IQOS 3 Multi.
- Product mix wise, the IQOS 2.4+ will continue to be marketed as a lower-cost offering to consumers, while IQOS 3 and IQOS 3 Multi will be offered as a premium product.
STOCK IMPACT
Growth from Japan tapering off, focus on European demand.
- Demand for IQOS remains strong, but it is clear that growth in its key market Japan is slowing. Given the strong take-ups from Europe/Middle East & Africa, attention will likely shift to the take-up rates there. However, we expect growth to be slower as a whole compared to that in Japan.
- Overall, the environment is conducive for more device production, though it appears that growth rates do not support the case for two suppliers unless a US launch occurs.
Sales of IQOS 2.4+ do not really matter beyond a gauge for device demand.
- Focus should shift to the next-generation IQOS as that is the production play going forward. Based on PMI’s comments of making IQOS 2.4+ a lower-cost offering, it is likely they have built up a substantial inventory.
- With the launch of a next generation device, PMI will likely be ceasing production of older models.
IQOS 3/IQOS 3 Multi production targets are likely to be more conservative.
- In order to deplete IQOS 2.4+ inventories, it is likely they will use it as the initial offering to new users. On this logic, the IQOS 3/IQOS 3 Multi will likely be targeted mostly at the growing user base of 5.9m, thereby pointing to more conservative production targets until inventories of IQOS 2.4+ depletes.
IQOS 3 Multi design is a threat to VMS production.
- We believe that the IQOS 3 Multi (Multi) is being built exclusively by FLEX, while Venture Corp holds the production rights to IQOS 3. The Multi is an integrated battery & holder, with various media sites suggesting it allows 10 consecutive smokes.
- Comparatively, the IQOS 3 allows only one smoke before a recharge is required in the accompanying battery pack. In order to chain smoke, a user will need two holders. The ability to chain smoke while carrying only one device vs having to carry one battery charger and two holders makes the Multi a superior design.
- Furthermore, the form factor is similar to a standalone IQOS 3 Holder, coming in slightly longer at 120mm (IQOS 3 is ~92mm long). The only variance is price, of which the Multi is reportedly cheaper. It is little surprise as to why PMI management sounded more excited about it.
- As an exclusive design to FLEX, the worry here is that demand for IQOS 3 wanes and its design becomes obsolete, putting Venture Corp' future production at risk. This would result in FLEX becoming the primary supplier, with Venture Corp playing second fiddle, fitting perfectly into a scenario where PMI pivots to a low-cost, high-volume supplier. Alternatively, PMI could choose to run a 2-tier device market that sees Venture Corp producing the lower cost variant but as we have seen from Apple's attempts at the iPhone 5C that might not work out.
EARNINGS REVISION/RISK
No change to 2018-20 earnings estimates.
- Our estimates have not taken into account the incremental IQOS 3 production for 2018. Factoring it in will result in a 1-3% increase in earnings. Earnings forecasts for 2019-20 could be revised: the IQOS production outlook is typically firmed 1-2 months beforehand.
- For the rest of the segments, our growth assumptions are unchanged.
Maintain HOLD, target price unchanged at S$18.20.
- Our target price remains unchanged at S$18.20, pegged to 14x 2018F PE.
- We are staying pat on our valuations given the high variability from IQOS, whose production outlook next year remains unclear.
- We do not think current levels are a buying opportunity yet. As it stands, consensus earnings face downside risk if our described scenario pans out. However, this changes completely if US FDA approval is received, whose timeline remains uncertain still. As such, we opt for a lower entry price of S$15.50 to provide a better margin of safety.
Key risks:
- Venture Corp could counter any near-term share price weakness by providing a higher- than-expected year-end dividend.
- US FDA approval comes in during 2019, prompting higher production for all suppliers.
Foo Zhi Wei
UOB Kay Hian Research
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https://research.uobkayhian.com/
2018-10-22
SGX Stock
Analyst Report
18.200
SAME
18.200
