I remain bullish on Philip Morris (PM), the world's leading tobacco company, as it has a diverse geographical revenue base, a solid dividend yield of 3.8% and attractive valuations as compared to its peers (as shown below). Also, the company offers a potential price appreciation of almost 11%, based on my price target of $99.
PM reported its financial results for 2Q2013, which were slightly below analyst estimates. The company reported net sales of $7.9 billion, missing consensus estimates by $0.32 billion. The company's top line was adversely affected by currency movement and lower cigarette shipping volumes. In its earnings release, the company disclosed that cigarette shipments fell by 3.9% in the quarter as compared to 2Q2012. Volumes fell in all markets for PM. The volume of traditional cigarettes is falling due to health concerns, intense competition and tougher regulations imposed on the tobacco industry.
Earnings per share for the recent quarter decreased by 4.4% YoY to $1.3, marking an earnings miss of 11 cents. Unfavorable foreign currency movements shaved away 7 cents from the recent quarter's EPS. As the company has international market exposure, foreign currency remains a headwind. The U.S. Dollar has been strengthening against other currencies in recent times, and the trend is expected to continue as fear prevails that the Fed will taper the ongoing asset purchases. Unfavorable currency movement is expected to cost almost 31 cents/share for the full year 2013.
Margins for PM dropped slightly in 2Q2013, mainly due to higher cost of sales and increases in marketing, administration and research costs. The following table shows the margins for PM:
Source: Earnings Release and calculations
Dividend and Share Repurchases
PM currently offers a decent dividend yield of 3.8%. During the recent second quarter, the company declared a regular quarterly dividend of $0.85, making an annualized dividend rate of $3.40 per share. I believe the dividends offered by the company are sustainable, as it has a healthy free cash flow yield of almost 5%. Also, the company generates strong free cash flows and has little capital expenditure (CAPEX) requirements, which indicate that the dividends paid by the company are safe.
The following table shows the free cash flows and dividend comparison (dividend coverage ratio), and CAPEX as a percentage of sales for PM.
Dividend Coverage Ratio (Free Cash-flow/Dividends)
CAPEX as % of Sales
Source: Annual Reports and Calculations
Other than the solid dividend yield of 3.8%, the company has been undertaking an attractive share repurchase program. PM spent $1.54 billion to repurchase 16.7 million shares under its ongoing three year share repurchase program of $18 billion. Since May 2008, PM has spent a total of $30.9 billion to repurchase 522.3 million shares. Share repurchase remains an important tool for the company to share its successes with its share holders and boost its EPS.
Stock Price Catalysts
Product innovation is another important stock price catalyst for PM. As volumes of traditional cigarettes are declining, PM has been aggressively working towards new products to tap market opportunities and fuel its earnings growth. Within the next five years, the company plans to introduce three different kinds of 'Next Generation Products'. Among other important stock price catalysts are the scale of the future share buyback program, the ability to increase prices to offset the impact of volume decline, significant emerging market exposure and cost saving initiatives.
Declining traditional cigarette volumes remain a problem for the tobacco industry. Volumes for the industry are declining due to a shift in consumer preferences towards alternate tobacco products and tougher regulations. Also, a possible VAT increase in Italy from 21% to 22% poses a risk to the company's financial performance. Italy is among the most profitable markets and contributes almost 9% to the company's total operating income. VAT, which was due to take effect last month, has been delayed until the fourth quarter of 2013.
The company has forecast EPS for 2013 full year to be in the range of $5.43-$5.53, as compared to $5.17 in 2012. Excluding the foreign currency impact, the company expects EPS to increase by 10%-12% YoY. In contrast, analysts have estimated an EPS figure of $5.55 for 2013. Also, analysts are forecasting a high next five year growth rate of 11% per annum. Following are the three-year analysts' earnings per share forecasts for PM.
EPS est. (Base case)
EPS est. (Bull Case)
I remain bullish on PM, despite the sales and EPS misses for the recent second quarter. The company has significant international market exposure that is likely to fuel growth. Also, the company owns a dominating market share of almost 29% (excluding China and the U.S.). Moreover, PM has a lower PEG of 1.45 as compared to its peers' average of 1.75, which indicates that PM offers cheaper growth as compared to its peers.
Reynolds American Inc. (RAI)
Lorillard, Inc. (LO)
Source: Yahoo finance
Furthermore, based on my price target of $99, PM offers investors a potential price appreciation of almost 11%. I calculated my price target of $99 using the S&P 500 forward P/E of 15.10x and 2014 EPS analyst estimates of $5.46. Due to PM's significant international market exposure, I applied 20% premium to the S&P forward P/E of 15.10x to calculate price target.
S&P 500 forward P/E
EPS est. 2014