For someone interested in income investing, one of the leading questions of the day is, "What the heck can I buy today that is a high-quality asset that is also fairly valued and offers reasonably growing income over the next 5-10 years?" One such company that falls into that category is Philip Morris International (NYSE:PM).
The international tobacco giant made $5.26 per share in net profits last year, and today's price of $89 lets you capture a 5.91% starting earnings yield, as the current price permits you to get in at 17x earnings. That's not bad, especially considering that in the days when Philip Morris International was spun off from Altria (NYSE:MO) during the start of the financial crisis in 2008 and 2009, the shares traded at 14x and 13x earnings respectively.
Someone who buys Philip Morris International today at the 17x earnings range is getting a fair shake; if the business and dividends grows at 8%, your returns will closely approximate that. In other words, P/E compression or expansion is not going to be at play with holders of Philip Morris International getting in at these prices. If you choose to buy today, you're effectively saying, "I'm content to receive returns that mirror the growth of the business."
That's not a bad place to be. Despite the fact that Philip Morris International does have some drawbacks (we'll get to those in a minute), it is nevertheless doing a lot of things right. Over the past five years, it has grown revenues by 8% annually, improved cash flow 8.5% each year, and the earnings have grown by 9% as well each year. The dividend, meanwhile, has grown by 26.5% annually over that time frame (it should be noted that dividends will come to mirror earnings growth sooner rather than later, as most of that dividend growth has been the result of increasing the dividend payout ratio from 30% of net profits five years ago to 67% now).
As a matter of strict business performance, Philip Morris seems to be doing an excellent job of improving its core metrics of profitability. The company has increased revenues since they have been independently tracked in 2006 at $48 billion to over $80 billion today, and this has allowed Philip Morris to simultaneously increase its net profits from $6.1 billion in 2006 to $8.5 billion in 2013 (and this growth allowed Philip Morris to retire over 400 million shares of stock through an aggressive buyback program that continues to this day). Meanwhile, Philip Morris's returns on total capital have increased sharply from 37.3% in 2006 (again, the first year that independent tracking was available before the 2008 spin-off) to over 55.7% by the end of 2013.
Why is it, then, that Philip Morris International shares are trading at a fair value range when (1) Philip Morris International has such a strong track record, and (2) most other large American stocks seem to be trading at a slight premium to fair value? Because volume shipments have declined by 7.5% in the European Union.
As noted by the Trefis team in Forbes earlier this week:
"This has been primarily due to increasing excise taxes, high unemployment rates due to weak macroeconomic conditions, the growing prevalence of illegally traded cigarettes and shifting consumer preferences towards other tobacco products. We expect Philip Morris International's shipment volume to the EU to continue to remain under pressure, as we do not see these trends easing drastically in the short term."
To me, the appeal of owning something like Philip Morris International is that the company has such diverse profit streams that you don't have to unduly worry about the performance in a particular market at a given point in time in order to achieve satisfactory returns. More specifically, European Union countries only account for 30% of Philip Morris International's business, and steady volumes in the "other 70%" (Africa, Asia, and Eastern Europe), plus a stock repurchase program act as countervailing forces that soften the difficult business environment in the EU.
In short, my argument for Philip Morris International amounts to this: there aren't many non-cyclical dividend growth companies that have been growing earnings at 9% annually that offer a starting yield over 4% and trade at 17x earnings or cheaper. Even though volumes declined by 7.5% in the EU this past year, that drop was unusually harsh, and Philip Morris still demonstrated the strength to handle adverse conditions by increasing earnings per share from $5.17 to $5.26. If Philip Morris can have an unusually difficult business environment and still grow profits per share, shouldn't you interpret growing profits through tough parts of the business cycle as proof of a hardy investment, and take advantage of the fair value in stock price created by the unusually harsh business conditions?
Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.