Philip Morris: A Great Opportunity Is Arising

Jul. 9.13 | About: Philip Morris (PM)

Philip Morris (NYSE:PM) is the second greatest tobacco company in the world, after the Chinese National Tobacco Corporation (CNTC). Most investors do not even bother to check out tobacco companies because there are always negative surprises around the corner, such as great restrictions on smoking and heavy taxes imposed by more and more countries. However, Philip Morris exhibits some unique advantages and hence I suggest taking a closer look at this company.

Diversification

First of all, Philip Morris is thoroughly diversified, performing its sales in more than 200 countries, and hence it is not greatly dependent on any single country. Therefore, it can withstand any country-specific headwind, as the negative effect is easily outweighed by the great performance in the other countries. Examples of great headwinds that were not sufficient to reduce the earnings of the company were the huge tax increases that were established in the Philippines (2013, average increase more than 200%), Mexico (2011), Australia, Greece, Romania, Turkey (2010), Brazil and Ukraine (2009).

On the other hand, the other well-known tobacco companies, such as Altria (NYSE:MO), Reynolds (NYSE:RAI) and Lorillard (NYSE:LO), operate mainly in the US, which is a more tightly regulated market with much narrower prospects for growth. In the tobacco market, which always hides negative developments, one does not want to be invested in a single country because a particular headwind would greatly affect the whole investment. Therefore, the great diversification of Philip Morris constitutes a significant advantage.

Performance

The benefit from diversification is evident in the company's performance, which has not been impaired by the above mentioned tax hikes. Since its spin-off in 2008, Philip Morris has increased its earnings by 28% and its earnings per share (EPS) by 81% thanks to its aggressive share repurchases. The company is run exceptionally well by a competent management, which has managed to overcome all the headwinds of the tobacco industry and has raised the global market share of the company from 25% in 2007 to 29% in 2012.

Debt

Another strong point of Philip Morris is its low net debt, about $34 B, which is less than 4 times its annual earnings. Therefore, the company can easily serve its debt and may actually keep raising it at the current low interest rates in order to enhance the returns to its shareholders, as the company has proved to be very shareholder-friendly.

Distribution to shareholders

Philip Morris has pronouncedly raised its dividend every year and is currently offering a dividend $3.40, which corresponds to a yield of 4%. Even better, the company is expected to raise its dividend in the next two months. Moreover, the company performs aggressive repurchases of its own shares; it has purchased 18% of its shares in the last 4 years and has announced a new 3-year share buyback program of $18 B. At its current share price of $87.5, the company can repurchase about 13% of its outstanding shares, thus further enhancing its EPS.

The aggressive share buybacks come with an added bonus. When the stock falls, the company can repurchase more shares with the specified amount of $18 B, thus further enhancing its EPS. This fact makes the stock more defensive, i.e., the decline during a temporary correction in the stock market is limited and is actually beneficial to the shareholders as long as the long-term perspective of the company is intact.

Future growth

In its annual report, the company mentions that there exists great growth prospects in many emerging countries such as Vietnam, India, Korea, Egypt, Bangladesh, Thailand and Taiwan. Furthermore, for the really demanding investors, the company is rigorously trying to cultivate ventures with Chinese National Tobacco Corporation. As China represents a growing 2.5 trillion cigarette market and the annual total sales of Philip Morris are 927 billion cigarettes, an 1% increase in the market share of China would represent a 3% revenue increase for Philip Morris, which is almost 3 times its last year's revenue improvement.

Recommendation

The guidance of EPS $5.60 for this year means that the company is rationally valued at the moment, at a forward P/E of 15.5. The share has range-traded between $80 and $95 for more than a year. If the company disappoints even slightly the market on its earnings announcement (July 18th), a great investment opportunity will arise. A possible reason for missing analysts' estimates is the stronger dollar but the share will anyway head south if the whole market corrects, which is quite probable at the moment. Therefore, although the shares of this exceptional company can be bought even at the current levels, one may wait for a somewhat better entry point. From a technical point of view, I would buy at $84-$85.

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in PM over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.