Weaker IQOS production could hit the firm hard as it contributes to 25% of revenue and 40% of profit.
The I Quit Ordinary Smoking (IQOS) smokeless cigarette device that Venture Corporation creates for Phillip Morris International (PMI) made up to 25% of 2017 revenue and 40% of gross profit, UOB Kay Hian noted. However, the production share of IQOS is shifting away faster than expected.
“The combination of an unexpected slowdown of sales in Japan, the price war with Japan Tobacco, and competitor FLEX’s lower cost of production has seen IQOS production share shift away from Venture faster than we had expected,” said UOBKH analyst Foo Zhi Wei. “Actual orders are coming in lower than the original production outlook had suggested.”
Apart from IQOS, 2017 also saw the test & measurement/medical (T&M/Med) segment (ex-IQOS and Illumina) exhibit strong growth. “Whilst its key clients continue to report a positive growth outlook, Venture’ momentum might be slowing going into 2019. Revenue growth might revert to historical averages,” Foo added.
The analyst noted that result transcripts of clients in the networking/communications and T&M/Med segments continue to report a mostly positive outlook for 2018. “The growth appears strongest from T&M clients, as they either report accelerating order growth or are raising their guidance for 2018,” he said.
Meanwhile, headwinds are seen for Waters, whilst Illumina sees the rate of growth moderating. For networking or communication clients, growth is moderating (Broadcomm).
Despite the T&M segment’s bullishness, expected growth is insufficient to arrest the decline from IQOS. Growth for the T&M/Med segment (ex-IQOS) is currently estimated at 8% YoY, which is at the low end. “Even if growth was to exceed 20% YoY in 2018, earnings are still likely to come in below $400m due to the outsized contributions from IQOS,” Foo said.
Consequently, the sharp growth momentum seen in 2017 is slowing, with the risk of production slowing below 2017 levels. “This stems from IQOS’ diminishing contributions as production shifts away to FLEX, and slowing growth in the ex-IQOS, ex-Illumina T&M/Med segments. We would turn extremely cautious going into 2H2018 if production does not ramp up further, resulting in an earnings decline,” Foo said.
The analyst trimmed profit growth forecasts to 16-34% for 2018-2020 as IQOS’ significance diminishes. Venture used to derive above-average margins from producing IQOS.
“With production declining, margins are expected to start compressing going into 2H2018,” Foo said. “With this and slowing growth momentum from the T&M/Med segment, earnings growth in 2018 will moderate or even decline.”
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