Clearly the macro story in Europe is having an impact on full results, but, outside of Europe, Phillip Morris (the international operations spun out of Altria in 2008) sees sustainable corporate advancement. Revenues in Q4 2012 were up 6.4% with organic cigarette volume growth of 2.9%. For Full Year 2012, organic volume growth was 1.3% to 927 billion units.

The strongest regions continue to be Asia and the Middle East (EEMA), showing volume gains of 4.2% and 4.6%, respectively. But inside the European Union, volume growth declined 6.4% with Southern Europe (as expected) shrinking the fastest. In Italy, for example, volume was down 7.9% in 2012 as price increases in that macro environment led to dramatic consumer changes. Cigarettes, at least those in the global manufacture sector, may be recession-proof but perhaps not depression-proof.

Despite European travails, Phillip Morris saw gains in its two most important global brands in terms of market share. Marlboro increase market share in every geographic region. For its part, Parliament (the “above premium” brand) achieved double-digit volume growth to 43.4 billion units. Overall, the company’s global market (ex US & China) hit a record 28.8%.

Morris was able to translate these volume statistics into revenue growth of 5.6% (ex currency) as some price increases were pushed through volume channels. On that, cost controls were effective in increasing operating margins to 45.2%, above the 44.1% seen in 2011. That yielded adjusted operating companies income growth of 8.1%, and full year EPS (fully diluted) growth of 11.7%.

Phillip Morris has been returning cash flow to shareholders since its spin-off, having repurchased $50 billion in stock (23% of all shares outstanding at the time of the spin-off) and increased dividend rates 85%. This shareholder strategy, of course, requires free cash flow in significant quantities. For Full Year 2012, the company saw FCF of $8.4 billion, down 11.6% from 2011.

On the conference call management explained that cash flow decrease as a function of dramatic working capital needs in Indonesia. The company, according to management, wanted to boost inventories (both leaf and finished products) to account for volume growth and restocking after an unexpectedly strong sales environment in Japan in 2011. In addition, the inventory accumulated was a more expensive clove crop – there was no word as to whether the interest in obtaining excess clove inventory was a result of inflationary expectations or anticipated product/crop shortages. In total, working capital needs grew by some $1.7 billion.

For 2013, however, Phillip Morris does not anticipate the same inventory pressures, but does note that inventory is not always easy to anticipate. Current forecast for FCF is to outgrow earnings and EPS (somewhere better than 10% – 12%). That would keep the company inline with cash estimates necessary to further the shareholder return strategy (despite struggles in European macro). It currently expects to repurchase another $6 billion in shares (out of the newly authorized $18 billion).

Aside from those economic factors, we still need to be mindful of the global regulatory environment. There will be a large excise tax increase in the Philippines (from 12 to 25 pesos per pack of Marlboros and from 2.75 to 12 pesos per pack of Fortune). There is no definitive estimate on how these increases will affect volume, but the company rougly expects a 20% – 25% decline in overall Philippine volumes.

In the EU, the Tobacco Products Directive is still being formulated and may eventually curtail volume growth in that region. The company does not expect a full agreement before 2014, and rollout is not realistic until 2015 or 2016 at the earliest. Currently, there are some drafts that would ban Menthol and slim products (10% of markets in Europe), but nothing definitive has been circulated.

That gives the company a few years breathing room to anticipate and shift product strategies, but will nonetheless require some additional investment consideration at each regulatory stage. Again, the main factor in the stock is cash flow and the ability of the company to deliver and transform price and volume growth into excess cash. They have shown that they can deliver margin improvement in a tough environment, now we need to make sure it can be sustained with governments searching for their own revenues.