Philip Morris International Inc. (PM), through its subsidiaries, engages in the manufacture and sale of cigarettes and other tobacco products in markets outside of the United States. The company was spun off from Altria Group (MO) in 2008, in an effort to separate the international operations of the tobacco conglomerate from potential harmful litigation in the US. I own shares in both companies. Check my analysis of Altria Group here.
PMI has not raised distributions for over a decade, like other stocks I focus on. I do however like the fact that the dividend raising culture of Altria Group has been closely followed since the 2008 spin off. The company has managed to raise distributions every year since 2008. I like the economics of the tobacco business immensely.
First, the company has a strong brand name for its quality products. A large portion of what consumers pay for cigarettes goes to pay excise taxes, and only a small portion goes to the tobacco company. Whiles taxes are raised every year, the level of profits always tends to increase at a higher rate than the drop in tobacco consumption. This supports higher earnings, which translates into higher distributions and increased amounts for stock buybacks.
Tobacco products are highly regulated, which means that there is little competition in the form of new companies coming to the market. In addition, most companies cannot freely advertise products, which translate into higher cash flow amounts being freely available for distributions.
Another positive for PMI Group is that legislation in the rest of the world is not as severe as it is in the US, although it could be getting there. Big tobacco companies like Philip Morris face similar restrictions in the EU, just like they do in the US. However, given the fact that tobacco companies fill in government coffers with billions in taxes each year, it is highly unlikely that governments would allow cigarette companies to lose money because of lawsuits. It would be fairly difficult for governments to replace the lost taxes from abolishing tobacco products. Growth for Philip Morris International (PM) should come from several sources.
The first source includes generating cost efficiencies in its cost reduction programs. A second source of growth includes growth through acquisitions. The company has been active in the acquisition front since striking out on its own by purchasing Rothmans in 2008 and Swedish Match South Africa in 2009 to name a few. The third source of growth for PMI includes strategic product innovations in growing markets, in order to position itself in specific country’s markets. Last but not least, tapping into the growth of emerging markets such as China and India, where it has a low presence could provide another opportunity for future growth.
There are several risks behind Philip Morris International that investors should be aware of. First, while it has operations throughout the world, almost half of revenues come from the EU, which is a mature market with declining demand. The market in EU is similar to that in the US with its constraints on marketing and public smoking. A second risk factor is potential proposed legislation that would require plain packaging by cigarette manufacturers, which would be harmful for tobacco brands like Marlboro, Parliament, L&M etc. Another risk for Philip Morris is tobacco smuggling. In some emerging markets it is “relatively easy” for third parties to sell smuggled products at lower prices or to sell “counterfeit” products. Such products erode tobacco conglomerates market shares and could lead to further increases in taxes.
Overall analysts expect Philip Morris International to increase its earnings per share to $4.42 in FY 2011 and $4.90 by FY 2012. This would be a nice increase from the 2010 EPS of $3.92. Future EPS growth would also be aided by share repurchases. Unlike most other companies, PMI maintained its stock buyback program even during the most recent bear market.
Currently, Philip Morris International is attractively valued at a P/E of 16.60, yield of 4% and a dividend payout ratio of 65%. The stock fits my entry criteria and I will be adding to my position in it when cash is available and provided my asset allocation allows me to do so.
Disclosure: Long PM and MO