Keep A Long-Term View On Philip Morris

Jan.20.12 | About: Philip Morris (PM)

Philip Morris International (NYSE:PM) has seen its share price drop significantly the past week, after a few analyst downgrades. Citigroup lowered earnings per share estimates and set a $75 price target on the stock, Goldman Sachs downgraded shares from “buy” to “neutral,” and maintained an $80 price target, and analysts at Davenport also downgraded the stock to “neutral” from “buy.” Bank of America analysts actually raised their price target to $85.

It is fairly easy to see the factors that each of these analysts looked at in arriving at their conclusions. Citigroup was likely looking at the fact that in Q3 2011, PM derived 30% (2.5B out of 8.36B) of its revenue from the European Union. The euro has weakened significantly against the dollar over the past month, so PM will certainly take a hit to earnings when the European sales, for which they are paid in euros, are translated into U.S. dollars. Anyone with a short-term focus will want to be aware of this fact.

The Goldman Sachs action makes the most sense. GS had an $80 price target on PM stock, and it reached a 52-week high of $79.96 on 1/3/12. There’s no sense in maintaining a buy rating if you believe the upside to be 4 cents. The Davenport analysts likely followed a similar thought process.

What is truly amazing is that these changes in analyst recommendations have actually caused the price to fall back to just under $74 per share. This shouldn’t be, and a fairly simple calculation can illustrate why. Let’s say you buy PM today for $74. In one year, the GS analysts prove to be 100% right, and you are able to sell the stock for $80. You’ve made a $6 profit on the stock, and you will also collect at least $3.08 in dividends (current quarterly dividend of 77 cents per share four times. I say “at least” because I think there is almost no chance of a dividend cut, but a very good chance of a dividend increase over the holding period). So you’ve made $9.08 on a $74 investment, for a return of 12.27% - pretty good for a stock with a beta of 0.8.

So you can see that the analyst downgrades have presented an opportunity for those of us willing to take the long-term view on this stock, which is likely what the Bank of America analysts are doing. I outlined in a previous article how well PM the company and PM the stock have performed since being spun-off from Altria (NYSE:MO) in 2008. I won’t recount it all here, so I suggest reading it if you are unfamiliar with the story. All the positives mentioned in that article – the increasing dividend, the share buybacks, and the growth in sales, are still in place for PM. Over the long term, the euro will rise and fall against the dollar, PM will continue to increase dividends, and earnings, and buy back shares. You simply have to decide if your expected return on PM will be greater, less than, or equal to the 12.27% I outlined above, and whether or not that return is sufficient for you.

Disclosure: I am long PM, MO.