Philip Morris International Inc. (PM), through its subsidiaries, manufactures and sells cigarettes and other tobacco products. Its portfolio of international and local brands include Marlboro, Merit, Parliament, Virginia Slims, L&M, Chesterfield, Bond Street, Lark, Muratti, Next, Philip Morris, and Red & White. The company was created after the spin-off of Altria Group’s (MO) international operations in 2008.
The spin-off was orchestrated in an effort to separate international operations from regulation and litigation risk in the US.
Philip Morris International has managed to boost distributions in each year since the spin-off. Quarterly distributions have increased from 46 cents/share in 2008 to 77 cents/share in 2011. I expect low double digit growth in distributions over the next five – ten years. This will be driven by strong performance by company’s brand name products globally, which will drive profitability higher.
The growth in earnings per share will be driven by several factors. The company expects to generate 10%- 12% annual growth in earnings through its cost reduction programs, acquiring companies internationally as well as innovating in growing markets in order to position itself favorably.
This company has strong pricing power for this addictive product. Taxes represent a high proportion of the sales price for every pack of cigarette and they are increased every year. As a result, it is very easy for companies like PMI to increase amounts of revenues it generates from each pack sold and still manage to offset the effect of lower consumption over time. PMI's pricing is strong, as consumers tend to stick to cigarettes they are used to. Another way that the company will be able to generate increases in earnings is through cost containment and efficiency measures.
Internal growth could be aided by redesign of packaging, introductions of new products as well as expansion in new markets. Phillip Morris International does not have significant exposure to China and India, which account for over a third of world population. The number of smokers is likely to increase in emerging markets, while in mature markets such as Europe it will likely decline over time.
In addition, the company plans to grow through acquisitions. In recent years it has managed to create joint ventures in the Philippines and Sweden. It has also been active in acquiring Rothmans in 2008 and Swedish Match South Africa and Petteroes in 2009.
Phillip Morris International generates a healthy amount of cash flows each year. A portion of this cash flow is used in stock buybacks. The number of shares outstanding has declined from 2.076 billion in 2008 to 1.762 billion in 2011.
There are many challenged facing the cigarette manufacturers. Smoking is associated with health issues, consumption is declining, there is increased government regulation and there is also the risk of litigation. Because of all these risks, tobacco stocks have historically traded at low P/E ratios and paid above average dividend yields. While tobacco companies could lose everything if the product is banned, the likelihood of that happening is remote. The reason behind it is the fact that cash strapped governments worldwide generate vast amounts of revenues by heavy taxation of tobacco products. Thus, governments would be unlikely to sacrifice this cash cow, since they would have to find other ways to increase taxation. Taxing cigarette consumption is a popular tax, whereas taxing income or reducing health benefits would be hugely unpopular measures.
The heavy regulation, high excise taxes, inability to advertise in most markets, and risk of litigation create barriers for entry that prevents new competitors from entering the market. As a result, large and established conglomerates such as Phillip Morris International can enjoy a strong pricing power, and a wide moat.
Currently, PMI is trading at 17.90 times earnings, yields 3.40% and has a sustainable dividend payment. I like the company’s high current yield as well as the potential for strong dividend growth. Phillip Morris International is already my largest position due to my bullishness for the stock as well as its strong performance. Nevertheless, I would consider adding to my position subject to availability of funds.
Full Disclosure: Long PM and MO
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