Friday, January 3, 2014

The Security I Like Best: Philip Morris International (PM)

Philip Morris International Inc. (PM), through its subsidiaries, manufactures and sells cigarettes and other tobacco products. The company has paid and consistently increased dividends every year since being spun-off from Altria Group (MO) in 2008. The last dividend increase was in September 2013, when the Board of Directors approved a 10.60% dividend increase in the quarterly distribution to 94 cents/share.

The company’s largest competitors include British American Tobacco (BTI), Imperial Tobacco (ITYBY) and Japan Tobacco.

Earnings per share have doubled over the preceding 7 years to $5.17 in 2012. The company expects earnings to reach $5.37-$5.42/share in 2013, followed by a 6-8% increase in 2014. Despite the near-term slowdown in earnings per share, the company is committed to growing currency neutral EPS by 10-12%/year after 2015.


The company spends a large portion of cash flow on stock buybacks. Between 2008 and 2013, the number of shares outstanding has decreased from 2.116 billion to 1.614 billion. When a company buys out one out of four shareholders at attractive prices, this makes remaining shares more valuable as each stock certificate has a higher share of the total earnings pie.

Growth in earnings per share could be derived from acquisitions or organically. Phillip Morris International has a high exposure to emerging markets, where number of smokers is increasing, along with their disposable incomes. This would offset decreasing volumes in developed countries in Western Europe, due to the Euro Crisis coupled with tough bans on smoking. The company can also squeeze out costs through efficiency containment programs.

Philip Morris International can also increase revenues by acquiring other companies in strategic markets. It has a proven track record of making acquisitions work, and making them accretive for shareholders. If the company manages to enter China on a large scale or through a partnership with the state owned company, this would be very beneficial for shareholders also. Unfortunately, the Chinese market is generally closed to foreign tobacco companies. It is estimated that a quarter of the Chinese population smokes, and that China’s mostly state owned tobacco industry accounts for 40% of the global tobacco market entirely through its domestic operations. China and Vietnam also present untapped opportunities for next generation products, such as Next Gen 1, which heats tobacco rather than burning it in order to derive the nicotine dose to the consumer.

As a company that reports in US dollars, but does business all over the world, Philip Morris International results are affected by fluctuations in currencies. Over time however, I view those as a wash.

PMI has a strong moat, because it would be extremely difficult for a new company to start and compete against the long established brands like Marlboro. Consumers generally stay with the brands they are used to buying. Cigarettes are an addictive product, which spots very good pricing power. In addition, PMI has the economies of scale which ensure that its costs stay low relative to the competition.

However, we have all heard that tobacco products could be dangerous to people’s health. Tobacco companies face a lot of hurdles such as increased restrictions on where people can smoke, increasing excise taxes, illicit smuggling of product, and increased hostility against it by governments. Those risks are widely known, which is why tobacco companies are usually cheap. That makes share buybacks particularly beneficial for long-term owners. The good part of PMI is that it generates revenues around the world, and therefore is not dependent on the actions of any particular government.

The plain packaging in Australia was a blow to the tobacco industry. The risk is that other governments could follow suit. The problem with plain packaging is that it could essentially destroy brands. Strong brands grow dividends, because they are sought after by consumers, and provide companies with solid pricing power.

However, this risk is mitigated by the fact that governments need the money paid by tobacco companies. It is much easier to tax the evil tobacco companies, than raise taxes across the board. Therefore, while governments have a love-hate relationship with big tobacco, they do need it at the same time. For example, when Australia started the plain packaging, this has resulted in lower tax revenues on tobacco products for the government, due to increase in illegal sales. By the way, Australia is not even mentioned when PMI discusses changes in annual volumes sold per region. So I do not see this as a big impact on PMI’s overall profitability thus far.

The company has managed to more than double quarterly dividends since it was spun-off from Altria in 2008. Quarterly dividends increased from 46 cents/share in 2008 to 94 cents/share by the end of 2013.

The dividend payout ratio is at 60% for 2012, and based on expected earnings for 2013 I see it at approximately 65% for 2013.

The thing I really like about PMI is that it is able to grow earnings organically, while also paying generous rising dividends to shareholders and consistently buying back stock. I am a firm believer that the company offers something that every serious dividend growth investor craves – solid underlying fundamentals, strong competitive advantages and a wide moat, widely recognizable brands, growth in net income, shareholder friendly management, decreasing number of shares and most importantly a commitment to increasing dividends. As a result, it is no surprise that Philip Morris International is one of the largest holding in my dividend portfolio at the time of this writing.

Currently, the stock is attractively priced at 15.80 times earnings, and yields 4.40%. If I were starting my dividend investment journey today, PMI would be high on my list for purchasing.

I am going to end up this article with the following quote from Warren Buffett :"I'll tell you why I like the cigarette business. It cost a penny to make. Sell it for a dollar. It's addictive. And there's a fantastic brand loyalty."

Full Disclosure: Long PM, MO

Relevant Articles:

Six Notable Dividend Increases so far in September
Seven wide-moat dividends stocks to consider
Strong Brands Grow Dividends
My Dividend Portfolio Holdings
The Dividend Investment Journey

11 comments:

  1. I've been looking at PM also recently. I already own MO. Try to figure out why PM is trading near its 52 week low while MO is near its 52 week high. Any thoughts??

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  2. PM is my heaviest position! I agree with your sentiments.

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  3. What are your thoughts of flat to declining volume sales? That is a huge negative since the e-cigs are becoming very popular, and not every country will fully ban them.. Even if PM sells E-cigs, they do not produce as much revenue as traditional ones. If just10-20% of the PM smokers start using E-cigs instead it kills off a huge chunk of revenue. PM is good at 15PE, but I feel like a little lower would be better to price in these big negatives.

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  4. The big tobacco stocks are money makers who continue to see growth but for how long? If governments continue to crack down on big tobacco then things could ugly fast. I own a couple of tobacco stocks but I admit I have mixed feelings about them both from a moral and financial standpoint. I love the earnings and dividends they provide but I fear the future could be dark. That being said I think it will be a long time before the political environment really puts a dent in earnings though.

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  5. The biggest risk with the tobacco companies is regulation. The fact that their products are subject to laws restricting and banning their products, regardless of the dividend to me the investment logic is flawed.

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  6. DGI,

    Good stuff. I also love me some PM. It's currently my second largest position, right behind JNJ. I think PM is attractively valued here, but I'm hesitant to add more here due to my allocation. It is quite tempting, however. :)

    Best wishes!

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  7. I really like PM as a stock. However, earnings could be better and its P/E is currently too high. I like them with a P/E in the 14 range and a yield at least better than 5%.

    Like you point out, dividend growth is excellent for PM and I think with the marketing of electronic cigarettes MO may also be another stock to look at more closely.

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  8. Hi DGI,

    To calculate the current P/E ratio of PM you are adding the EPS from the last four reported quarters, 1.44, 1.30, 1.28, 1.22, is it correct?

    Thanks,

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  9. Hello DGI,
    A few comments posted here underscore why the stock is usually undervalued, concern over regulation, etc. These concerns are underscored also in the Jeremy Seigel article, 'Ben Bernanke's Favorite Stock'. PM is my largest position, obtained sixteen years ago as part of the mighty Altria Group. The returns have been nothing short of fabulous. For some time now PM and MO have been working on e-cigs and are going to market along with other products. PM has reported that several of their board members have switched to the new products entirely. These offerings hopefully will soon include the product developed by Dr. Jed Rose, purchased by PM in 2009 and I believe under development.

    Tobacco company research indicates that most e-cig users are dual users, meaning they smoke too. E-cigs and similar alternative products are big because they may not be the replacement for cigarettes for many smokers, they will be a additional purchase for 'situational' use.

    This is a great company, with great opportunity, I can't say enough about it, I'm a buyer!

    A

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  10. I like PM and I have hefty position there. One concern I have heard from folks in the balance sheet. Liabilities are up, especially long-term debt. In addition, the company has negative shareholders equity.

    I know PM is a cash cow, but is the status of the balance sheet a concern?

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  11. Thanks for your great blog.

    While PM might be a good financial dividend investment, I find myself too reluctant to invest. Its product does cause lung cancer, and that's point I cannot get past.

    Similarly, although KO is likely as good a investment for dividends, its product (in my opinion at least) is a major contributor to diabetes.

    Not to say I am without contradictions myself, being human. Anyone owning shares in any company has a hand, ever remotely, in some inhumane conduct or destructive behavior. And I do own shares in a variety of companies.

    But some are more distasteful than others. And each of us, I would assume, has different vision of what distasteful is. I mention my own to be forthcoming.

    I do not consider myself an "ethical investor." For example, most of the time, health-related issues I mention does not come up in my deliberations to buy. But once in a while, such as in regards to PM and KO, it does.

    --Joe

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