This year hasn't particularly been nice to Philip Morris (PM). The company's share price started the year at $83, quickly rallied to $97 but gave back all the gains in the last few weeks. Currently, the company's share price is around $84, which is very close to the company's 52-week low price of $82. In this article, we will look at whether the correction brought the company to a level where we can call it a value play.
In recent years, there has been a huge movement to educate the masses about how bad smoking is and why it should be avoided. While, as a non-smoker, I believe that it is a great idea to teach people about dangers of smoking, things didn't turn out so well for companies like Philip Morris. Currently, cigarette companies are having trouble finding revenue growth, as younger people are looking at alternatives to smoking, such as e-cigarettes.
Philip Morris is working hard to achieve revenue growth in countries like China where every third adult is said to be a smoker. Currently, the company has an ongoing partnership with China Tobacco because the Chinese government doesn't allow the company to conduct business in the country directly. Because of the large size of the market in the country, China continues to be a strong potential for PM but the company has to sort things out with the Chinese government first. For the time being, the company will not be generating a lot of strong profits in China.
In Europe, while the governments are not as restrictive as the Chinese government, the European Parliament recently passed a ban and some restrictions on several tobacco products. The governments in Europe are waking up to the reality that smoking causes a lot of health problems and this is hitting their budgets badly because most European countries offer government-sponsored healthcare. While these governments also collect hefty taxes from tobacco sales, it is difficult to tell if these taxes can actually cover the damage done by smoking. For example, lung cancer is mostly caused by smoking, and American Cancer Society predicts that the cost of treating cancer might go as high as $10,000 per month. The new European ban will restrict advertisement and marketing methods of tobacco products, which may hurt the sales of such products in the continent. This didn't come as a surprise, as tobacco companies already knew a ban was coming, and they decided to take most of their growth initiatives to Asia and Latin America to offset the effects of the ban.
In Canada, PM is facing a huge lawsuit (along with several other tobacco companies) where the bill could go as high as $50 billion. If it is found guilty and gets charged, this lawsuit alone could impact the company in a big way. The province of Ontario claims that the treatment of smoking-related conditions cost the taxpayers $1.6 billion per year and the tobacco companies should pay some of the bill because they allegedly "misrepresented the risks of smoking in their marketing campaigns." Nova Scotia is the only province in Canada that didn't join the lawsuit. In the last 25 years, tobacco companies are said to have paid a total of $250 billion in a variety of settlements.
Last month, when PM delivered less than impressive results for the last quarter, many investors decided it's time to sell this stock. In the last quarter, PM reported net earnings of $1.30 per share whereas the analysts were looking for $1.41 per share. The company blamed the strength of dollar for the weak results and PM's shipping volume was up by only 3.9% compared to the same quarter a year ago. PM expects to earn between $5.43-5.53 per share for the full year (midpoint is $5.48) below analyst estimates of $5.55.
The recent plunge increased the company's dividend yield to 3.99% which is just short of the magic number of "4." A lot of times, when a company's dividend yield goes above 4.00%, a number of buyers focused on dividends come in and push the price higher. Recently, we saw this with Intel (INTC) as the company's shares saw a mini-rally after the dividend yield hit 4% (keep in mind that the company's yield is still above 4 at the time of writing of this article but it is not likely to stay there for long). At a time high-yield is difficult to find, 4% serves as not only a psychological entry point, but also an attractive yield opportunity.
The company's expected earnings of $5.48 gives it a forward P/E ratio of 15, which is fair for a company that grows at a mid-single-digit rate. Many investors are betting that PM will be able to see a lot of growth in Asia, particularly in countries like Philippines and China where smoking rate is high and the penetration is rather low.
Philip Morris is currently at a decent valuation given its future prospects and strong dividend yield. Of course, an adverse result in the Canadian courts might hurt the company badly depending on the size of the bill that will be paid by the company. At this point, I'm sure a large number of dividend investors are backing the truck up to load up on more shares though.