Philip Morris International Inc. (NYSE:PM) is the leading international tobacco company, with seven of the world's top 15 brands, including Marlboro, Parliament, L&M, Philip Morris and others. PM's products are sold in approximately 180 countries in the European Union, Eastern Europe, the Middle East, Africa, Asia, Latin America, and Canada. In 2012, the company held an estimated 16.3% share of the total international cigarette market outside of the U.S., or 28.8% excluding China and the U.S.
There is a lot to like about PM as an investment:
- It enjoys global footprint providing prospects of strong future growth, especially in undeveloped markets where health issues related to smoking are not a factor
- Its large market share enables some control over pricing
- It has extremely strong and stable cash flow
- Management is dedicated to returning cash to stockholders
- It invests in R&D to prepare low-risk alternatives for tobacco. Factories for these products are already being built and future market for them seems huge.
- As unhealthy as it may be for the customers - quitting using its product is a difficult mission
- But this investment is accompanied with risks:
- Developed markets try to decrease tobacco use
- Tough competition in each country PM operates
- High debt load - on this point I will elaborate below
Since it was spun off from Altria (NYSE:MO) in 2008, PM positioned itself among investors as a company with very strong cash flows and huge returns to stock holders:
Over the past 5 years (until June 30, 2013) this $140 Billion market cap company paid a total of $26.8B dividends (increased every year) and bought back $30.2B worth of stocks. These amounts are amazing by any measure!
Below are several metrics for PM and other 3 tobacco giants:
|Phillip Morris||Altria Group||Lorillard Inc. (NYSE:LO)||Reynolds American Inc. (NYSE:RAI)|
|Market Cap ($B)||140||70.6||16.48||26.23|
|Free Cash Flow (TTM)($B)||7.4||4.4||1.2||1.3|
|Price to FCF||18.81||15.93||13.54||19.57|
|Total Liabilities to Total Assets||1.11||0.90||1.56||0.67|
|Price to Book||--||19.64||--||5.1|
|Estimated 5 year Growth||10.03%||7.80%||12.50%||7.70%|
|Total Liabilities ($B)||41.3||30.8||5.2||10.4|
|Total Liabilities to FCF||5.55||6.96||4.26||7.79|
Several conclusions arise from the data above:
- PM's P/FCF for is somewhat high at almost 19 and so is the PEG at 1.55. These two ratios might indicate a slightly high price for the stock. Both MO and LO enjoy lower P/FCF ratio, LO has the lowest PEG indicating a cheap price compared to future anticipated growth.
- The current ratio for PM is fine at 1.14, indicating financial strength at least in the near future. That is correct for all four companies mentioned.
- Even given the decent expected 5-year growth rates, the defensive style and high dividends I find none of the companies' stock a bargain.
- PM's level of total liabilities to total assets is high. This is where I do not like what management is doing and why I think they are far too liberal with their stock buybacks and high dividends. Take a look at the table below:
|PM Metrics ($ Thousands)|
|Free Cash Flow||3,980,000||8,365,000||9,632,000||8,724,000|
|Stocks Buy Back||3,028,000||6,524,000||5,297,000||4,801,000|
|Returned to Stockholders in Excess of FCF||-1,863,000||-3,563,000||-453,000||-500,000|
As can be understood from the first line, the company's impressive FCF clearly shows a strong business model that is overall well executed, and enjoys exceptionally strong brands and global fingerprint. That can indicate a promising candidate to your portfolio.
But then, take a look at the huge pile of money the company returns to its stock holders as dividends and buy backs. What can be seen as a management highly committed to its stockholders can also be understood quite differently: the company consistently returns to its stockholders more money than it produced. It does so by assuming more and more debt every year.
In other words, PM's management loads debt and pays it to its stockholders.
Simply put, if I wanted to take a loan I would have done that myself. As an investor I would like cash flows from operations to be invested in future business growth first (CAPEX), then if the company's debt and other liabilities level is acceptable I would like excess cash returned to me.
…And then, on September 11, PM announced yet another anticipated 10.6% increase in its annual dividend. Its stocks bounced over 2.6% as a result.
As much as I like high and rising dividends, I would first like to see lower debt and liabilities levels first or alternatively more debt assumed for future developments, not for dividend hikes or stock buybacks. Therefore I do not join the party and am not happy with this divided hike.
PM can easily have a rock-solid balance sheet that will support higher valuations and help prepare for tougher times ahead. With the current situation I will stay on the sidelines, hope for management to start deleveraging and wait for a stock price decrease to the lower-mid $70s before I initiate a long position.
As for MO, LO and RAI - all 3 companies are strong players with well-known and established brand names. They all operate mainly in the USA and are considered defensive plays, mainly thanks to their solid cash flows and addicted customer base. LO seems to be the cheapest of them by most metrics. However, since they lack the global exposure of PM and operate in a market where the trend is to decrease tobacco use by legislation or by constantly discussing the related health hazards - I do not intend to start a position in any of them (at least not in current valuations).