Philip Morris: Not Just Blowing Smoke

Mar. 4.09 | About: Philip Morris (PM)

Philip Morris International Inc. (NYSE: PM) may have a smoky future, but some investors just can’t pass up the bargain price. The cigarette-maker hit new lows this week as a deteriorating global economy has dampened the outlook for many companies relying on discretionary consumer spending. However, low earnings multiples, a high dividend yield, and a solid earnings history has many investors interested.

A Strong Fundamental Case

Philip Morris is a very profitable company with an industry-leading brand portfolio. The company reported a 15.2% increase in net revenues and a similar 14.1% increase in net earnings in 2008 versus the prior year. Notably, the company faced higher tobacco leaf costs as well as increased marketing expenses that increased its expenses and weighed down on its earnings.

The global economic recession reduced demand in many European nations, including Germany, France, Italy, and Poland. However, volumes rose in several key markets, including Spain, Eastern Europe, the Middle East, Africa, Latin America and Canada. Strong growth in these many developing nations should offset declines in developed nations while providing for future growth when a recovery takes effect.

Philip Morris has also attracted many long-term investors with its low 9.8x earnings multiple and strong 6.64% dividend yield. The cigarette-maker has a P/E to growth ratio of just 1.18, with a 60% return on equity and strong free cash flows of around $7.6 billion last year. Combined, these factors make this a company that is attractive to many investors despite its 50% drop over the past 52-weeks.

The Key Risk: Lawsuits

It is no secret that Philip Morris and other tobacco companies are often targeted by consumer lawsuits. The primary product they produce has been shown to cause cancer and people tend to disagree on how much disclosure is required to smokers. While it is possible that these lawsuits could result in material losses, many regulators now agree on the necessary disclosure, and many lawsuits are dismissed.

Currently, Philip Morris has the following outstanding lawsuits:

  • 125 Individual Smoking and Health Cases
  • 5 Smoking and Health Class Actions
  • 10 Health Care Cost Recovery Actions
  • 3 Lights Class Actions
  • 2,010 Individual Lights Cases (Small Claims)
  • 12 Public Civil Actions

Despite the large magnitude of lawsuits, there has been very clear documentation of disclosures, and many of these lawsuits will be thrown out of court. Moreover, the small claims lawsuits are primarily in Italy where the claims are limited to EUR 1,000 each, which means the maximum losses in that division are capped at around EUR 2 million.

Looking Ahead

Philip Morris remains a very strong company despite the global economic decline and growing number of lawsuits. Emerging markets have shown strong growth in 2008 and should continue to perform well in 2009. Meanwhile, many of the lawsuits are likely to be thrown out as the company works to make proper disclosures in all of its markets. Overall, investors can now buy shares of a strong company at half the price of last year!

Disclosure: No position