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Summary

  • Questions continue about Tobacco stocks and Philip Morris in particular.
  • But, a yield near 5 year highs and a PE below 5 year average make Philip Morris look attractive here.
  • Earnings growth, new product categories, yield, and dividend growth promise double digit returns.

A recent article about Philip Morris (NYSE:PM) on Seeking Alpha argues that the future is not too bright for this stock. This article provides the counter arguments as to why Philip Morris is worth a look here. Let's get into the details.

5 Year High Yield: As of this writing, Philip Morris yields about 4.65%. This is very close to the highest yield point in the last 5 years. But hold on, it won't take long for today's buyers to reach or go above the 5 year high yield of 5.20%.

Philip Morris has been increasing dividends every year since the 2008 spin-off and that streak is hardly at risk right now. If the company sticks to its 5 year average dividend growth rate of 12%, the new annual dividend will be $4.20. That should put the yield on cost at 5.20% based on current share price of $80.90.

(click to enlarge)

(Source: YCharts.Com)

Valuation: Philip Morris is always thought of as the tobacco stock that trades at a premium compared to rest of the domestic/international tobacco stocks. But the current reality says otherwise. Philip Morris' PE of 15.42 is lower than those of Lorillard (NYSE:LO), Altria Group (NYSE:MO), Reynolds American Inc (NYSE:RAI), and British American Tobacco (NYSEMKT:BTI).

If that does not make the stock attractive already, take a look at the chart below. Right now, Philip Morris is trading below its 5 year average PE of 15.80.

(click to enlarge)

(Source: YCharts.Com)

Growth Prospects:

  • Philip Morris is introducing a hybrid cigarette in a few international markets to test the waters. While it is too early to say whether these experiments will be positive or negative in the long term, investors can take comfort from the fact that the company is not resting on its laurels.
  • Philip Morris also announced towards the end of 2013 that it is entering the very attractive E-Cigarette market. This segment is still in its infancy in the international markets. Philip Morris' brand name and distribution strengths should come handy here.
  • Ignoring any of the new initiatives, Philip Morris is still expected to grow earnings at 7% per year for the next 5 years. Add the cost cutting savings, stock buybacks, dividends and we are looking at a safe double digit return.

Countering The Negative Aspects: This section is to offer counter-points to the concerns raised in the article linked above.

  • Currency Fluctuations: There is very little that Philip Morris or any other company could do to control this. The dollar will be strong, the dollar will be weak. Over the long term, every company dealing in international markets will have a few quarters or maybe even years where exchange rates are unfavorable. The same goes for favorable conditions too.
  • Declining Revenue and Market Share: It is no breaking news that more and more people are aware of the dangers of smoking these days. But the point that is being overlooked is that companies like Altria (MO) (or Philip Morris whichever way you want to put it) have tremendous pricing power (source links here and here). Marlboro's price has been increased way too many times to count in the last decade. To understand the importance of brand name and pricing power, take a look at this quote from Charlie Munger:

"If I go to some remote place, I may see Wrigley chewing gum alongside Glotz's chewing gum. Well, I know that Wrigley is a satisfactory product, whereas I don't know anything about Glotz's. So if one is 40 cents and the other is 30 cents, am I going to take something I don't know and put it in my mouth-which is a pretty personal place, after all-for a lousy dime?"

  • Regulations: Tobacco companies have almost always operated in a regulated environment. Do not make the mistake of looking at Philip Morris International as a 6 year old company (since 2008 spin off). Altria's influence on this company is undeniable. The original Philip Morris continued to be a cash cow for investors through a combination of high yield, dividend growth, and moderate valuation.

Conclusion: There is no denying that Tobacco companies will see more and more regulations and hurdles. Investing is all about choices. Tobacco companies have among the highest yield in the market. When alternatives like a savings account, bonds, and even other tobacco stocks do not appear very attractive, there is no harm in sticking with a proven company and stock like Philip Morris. While Philip Morris also has insider selling, director Sergio Marchionne (Fiat CEO) continues to buy 1,000 shares almost every other month.

That said, investors must closely monitor trends with the new product categories like E-Cigarettes and Hybrid Cigarettes. Cost cutting, existing market share, and pricing power can take this company forward for the next few years but the new products are also critical for the very long term. So, the takeaway here is: no need to panic right now or even the next 5 years. But keep monitoring.

Disclosure: I am long PM, MO, LO. 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.

Source: Philip Morris - Still A Smart Investment Choice

Additional disclosure: Might sell LO in the next few days depending on how the RAI-LO merger talks affect the stock price.