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Summary

  • The anti-tobacco government regulation in its regional business segments and macroeconomic policies are threats to the company’s market share in its respective regions.
  • The company will not have the ability to show healthy EPS in the long term.
  • The large payout is dangerous for the company’s future growth.

Philip Morris (NYSE:PM) is the leading brand in the tobacco industry with the largest market share. PM is facing many risks to its core business segments due to the declining trend of tobacco sales. Reduced tobacco usage is a major risk factor about which PM investors' are concerned. It is believed that the declining trend will continue throughout the upcoming year which means a danger to the top and bottom lines of the company.

The Effect of the Declining Trend of Tobacco Usage on the Company's Business Segments

The company's European Union business unit is a 30 percent net income generator, and is making strategies to wipe out cigarette consumption. The EU is also applying heavy excise taxes on major imported cigarette brands which are causing the company's product price to rise. The company is keeping smaller shares of its earnings and the remainder goes to the government. These initiatives reduced 25 percent of cigarette consumption from 2000 to 2010. The company's EU sales volume has been declining for many years and this decreasing trend is expected to continue. This segment is critical to the company's future stock price as it contributes 26 percent towards PM's stock.

Furthermore, the company's second important business segment, Eastern Europe, Middle East and Africa, is also facing challenging conditions in the tobacco industry. Russia is the biggest tobacco market in the region and is causing difficulties for the company's revenue because of the anti-tobacco regulations. Last quarter showed a decline of 18.5 percent in volume generated by this segment. Speculations suggest that the company will have to face similar dangers in order to operate its business in this geographical region. The following table shows the reports of the forecasted year end revenues for each segment.

(click to enlarge)

Source: 10k

International Outlook

Moreover, the company's declining future in its major business segments is also related to macroeconomic factors like foreign currency exchange rate fluctuations. The company's business in many countries is running on the domestic currency of that country, so the company has to face translation risks. Keeping in mind the upcoming challenging trade between other countries and the US, many countries will become weaker compared to the US in currency terms.

Japan would be a concern for the company in 2014. The Japanese government is increasing its consumption tax in April from 5% to 8% and this could hurt Philip Morris's sales. Consequently, the company has applied to the Minister of Finance to seek approval to increase the prices of its products. However, this increase would negatively impact Philip Morris's position leading to a market share decline of 3% to 3.5% from 2% last year.

The company plans to cease its production unit in Australia due to the government's regulations against cigarette exports. Discontinuing a major operational business unit will cost the company a lot of money which will further reduce the overall net income and EPS. The company has been unable to expand its exports since the domestic demand of cigarettes is gradually decreasing.

Falling Sales Growth and Net Income

Although investors will see an increase in dividend payout in the short term, long-term investment in this stock is in danger. The rate at which the bottom and top lines are shrinking is a conundrum for the company's management. The following graph shows the effects of the above discussed factors on tobacco consumption in the past and future.

Source: Sydney Morning Herald

Sales, excluding currency fluctuations, are still increasing in Latin America and Canada. These regions generate more than 4-5 percent of total sales. This business unit is responsible of 7.68 percent of the company's stock price. The following table shows the forecasting of this year's end values of sales and net income which are clearly repelling investors from buying this stock.

Source: 10k

Revenue will decrease by negative 4.40 percent in this year resulting in sales of $76,508 million. This decline in sales is because of less tobacco usage. If this decreasing sales growth is continued in the upcoming fiscal years then investors should realize that the company is on the brink. Moreover, the company will have to pay huge amounts of money in excise taxes on products in its various regions due to government laws in the countries it operates. Net income calculated from the current year's end EPS is mainly low because of heavy taxes. Forward P/E means that the company's price compared to its future EPS is going to remain almost the same as it is now.

Large Payout Ratio Is A Critical Point

Investors might be satisfied with PM's lack of concern regarding its long-term growth because it pays continuous dividends, but the payout ratio of 65 percent is dangerous for the company in the long term. The company should increase its retaining ratio because once it retains more earnings that amount can be reinvested in to long-term projects. The company's management is even planning to increase its payout ratio which is an alarming sign for long-term investors.

Final Remarks

The declining trend of tobacco usage is a major concern for Philip Morris's long-term growth. With a large dividend payout, the company will have nothing to invest in its future projects to boost its sales. The European Union, a major business segment, is showing a downward trend which means negativity for the company. Investors who wish to gain from the company's long-term sustainability should sell their stock.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Business relationship disclosure: The article has been written by a Gemstone Equity Research research analyst. Gemstone Equity Research is not receiving compensation for it (other than from Seeking Alpha). Gemstone Equity Research has no business relationship with any company whose stock is mentioned in this article.

Source: Philip Morris International Will Fall Like Ash