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Introduction

Philip Morris International (NYSE:PM) is world renowned for its Marlboro brand cigarettes. The perks of owning this Tobacco company are the predictable yield, wide economic moat, and international growth. Defensive investors should always consider this investment for both good and bad times.

Qualitative Analysis

Source: Information pertaining to Philip Morris came from the shareholder annual report, with additional information from the Philip Morris quarterly report, and YCharts.

In 2012 Philip Morris did a poor job of growing its gross profit on a year-over-year basis. The gross profit only grew by 2.86%, with the highest rate of gross profit growth being 16.71%. I anticipate Philip Morris' year-over-year growth to fluctuate in a 16% range, and that the company is currently in the lower-end of the range. I also anticipate that Philip Morris will eventually generate gross profit growth at the higher end of its range in the foreseeable future, and that investors should not be concerned over short-term growth.
(click to enlarge) Philip Morris will command a higher gross profit in future years because it can raise prices in order to earn a higher gross profit without significantly affecting demand. This is because demand elasticity is 0.61 for tobacco products, meaning that if Philip Morris were to increase the price of its cigarettes by 10%, the demand would only decline by 6.1%. This bodes well for investors, and since the tobacco industry is extremely limited in competition it is highly likely that competitors would also raise prices allowing for consistent gross margin growth over time.

(click to enlarge) Source: Chart from New Zealand Treasury

Tobacco prices have consistently increased at a rate higher than CPI based on data in the past 3 years, meaning that tobacco companies are taking advantage of demand elasticity without hurting profitability. This can be proven based on the growth in its operating income in the figure below.

(click to enlarge)

Philip Morris International only operates in foreign markets. The advantages that come from operating in overseas markets include:

  • Less regulation
  • Higher customer conversion
  • Emerging markets have higher GDP growth

Bill Maurer believes that the liabilities should be a cause for concern:

I'm not worried about Philip Morris in the short term, that being 2013 or probably 2014 either. I am worried a little bit down the road if the company's debt pile continues to build, and if liabilities continue to rise quicker than assets.

I disagree with Bill Maurer on the balance sheet factors as an ominous signal for Philip Morris because Philip Morris operates a predictable business model that is likely to generate higher yields over time and the vast majority of the debt is long-term. Since the debt is long-term it is likely that Philip Morris will be able to pay-down its debts as it continues to improve its profit. High-debt in a cyclical business could be a cause for concern, but since Philip Morris is a non-cyclical business it should not be a significant concern to investors.

(click to enlarge)

Furthermore the free cash flow in the most recent quarter alone has improved by 89.1% and cash from operations has also increased by 71.7%. This was accomplished due to improved unit sales, but also due to price hikes on its tobacco products. This means that Philip Morris will be able to pay down its long-term debt balances in future years without hampering long-term growth.

Technical Analysis
Philip Morris is in a multi-year up-trend and I anticipate this trend to continue.

(click to enlarge)

Source: Chart from freestockcharts.com

The stock is trading above the 20-, 50-, and 200-Day Moving Average. The stock is in a confirmed up-trend (higher highs and higher lows); the up-trend further supports my buy-thesis.

Notable support is $72.50, $77.50, and $87.50 per share. Notable resistance is $92.50, $99.00, and $110.00 per share.

Street Assessment

Analysts on a consensus basis have reasonable expectations for the company going forward.

Growth Est

PM

Industry

Sector

S&P 500

Current Qtr.

8.00%

5.10%

186.00%

10.10%

Next Qtr.

11.80%

9.50%

117.10%

16.60%

This Year

10.70%

-8.40%

9.90%

8.90%

Next Year

10.70%

19.30%

-1.50%

12.30%

Past 5 Years (per annum)

13.52%

N/A

N/A

N/A

Next 5 Years (per annum)

11.03%

9.65%

13.73%

8.56%

Price/Earnings (avg. for comparison categories)

15.65

14.66

15.61

15.04

PEG Ratio (avg. for comparison categories)

1.42

1.84

2.01

1.97

Source: Table and data from Yahoo Finance

Analysts on a consensus basis have a 5-year average growth rate forecast of 11.03% (based on the above table).

Earnings History

12-Mar

12-Jun

12-Sep

12-Dec

EPS Est

1.19

1.34

1.39

1.22

EPS Actual

1.25

1.36

1.38

1.24

Difference

0.06

0.02

-0.01

0.02

Surprise %

5.00%

1.50%

-0.70%

1.60%

Source: Table and data from Yahoo Finance

The average surprise percentage is 1.9% above analyst forecasted earnings over the past four quarters (based on the above table).

Forecast and History

Year

Basic EPS

P/E Multiple

2008

$ 3.32

10.99

2009

$ 3.25

13.08

2010

$ 3.93

13.76

2011

$ 4.85

15.59

2012

$ 5.17

16.18

Source: Table created by Alex Cho, data from YCharts, and price history is from Yahoo Finance.

The EPS figure shows that throughout the 2008- 2012 period, the company was able to grow earnings.

(click to enlarge)

Source: Table created by Alex Cho, data from YCharts.

By observing the chart we can conclude that the business is non-cyclical and is able to grow earnings even through economic recessions. I also believe that so as long as the world economy continues to grow, the company will generate reasonable returns over a 5-year time span based on the forecast below.

(click to enlarge)

Source: Forecast and table by Alex Cho.

By 2018 I anticipate the company to generate $9.80 in earnings per share. This is because of cost management, growth in foreign markets, improving economic outlook, and its robust product offering.

The forecast is proprietary, and below is a non-linear chart indicating the price of the stock over the next 5-years.

(click to enlarge)

Source: Forecast and chart by Alex Cho.

Below is a price chart incorporating the past 5 years and the next 6 years. Detailing 11 years in pricing based on my forecast and price history on December 31st of each year.

(click to enlarge)

Source: Forecast and chart created by Alex Cho, data from YCharts, and price history is from Yahoo Finance.

Investment Strategy

PM currently trades at $90.99. I have a price forecast of $80.46 for December 31st 2013. I believe that the stock is slightly over-valued over the short-term. Therefore investors should position themselves for the long-term and ignore short-term volatility while accumulating shares in this defensive company.

Long Term

The company is a great investment for the long-term. I anticipate PM to deliver upon the price and earnings forecast despite the risk factors (competition, economic environment, balance sheet factors). PM's primary upside catalyst is improving economics, international growth, and price hiking. I anticipate the company to deliver upon my forecasted price target of $136.37 by 2018. This implies a return of 50.2% by 2018 when including dividends the total return is 73.2%. This is an exceptional return on investment for a non-cyclical.

Year

Dividend Yield @ $90.99 per share

Cumulative Total

2013

3.76

3.76

2014

3.79

7.55

2015

3.82

11.37

2016

3.85

15.21

2017

3.88

19.09

2018

3.91

22.99

Source: Forecast and table by Alex Cho, dividend data from YCharts.

The high-returns come with moderate risk (5-year beta of 0.9).

Philip Morris has a market capitalization of $152 billion; the added liquidity makes this an investment opportunity appropriate for larger institutions that require added liquidity.

Conclusion

Tobacco companies never go out of business which is why a strong defense will remain your best offense.

The conclusion remains simple: buy Philip Morris International.

Source: Philip Morris: A Strong Defense Is Your Best Offense