Shares of Philip Morris International (NYSE:PM) picked up a couple of analyst upgrades in the last month. Bank of America Merrill Lynch upgraded the company from neutral to buy on Thursday morning, and BNP Paribas upgraded Philip Morris from neutral to outperform on March 8. Bank of America Merrill's rating was due to slowed foreign exchange pressures.
Meanwhile, peer Altria (NYSE:MO) was downgraded Thursday morning by Bank of America Merrill Lynch.
I am not sure whether the recent analyst love for Philip Morris is due, and investors may have better luck in recently downgraded Altria.
Below we can see that both companies' valuations have been expanding relative to earnings in the last five years. On a trailing basis, Philip Morris is slightly undervalued compared to Altria.
PM PE Ratio (TTM) data by YCharts
However, using my preferred metric for earnings valuation, forward price to earnings, Philip Morris is slightly overvalued relative to Altria.
Given that most investors like tobacco companies' shares due to their cash cow status, it is helpful to look at the cash generation performance.
PM Free Cash Flow Per Share (TTM) data by YCharts
Altria has been far superior in the last few years growing free cash flow. As mentioned earlier though, foreign exchange has been a large issue for Philip Morris, being an international seller. The chart below shows the dollar index over the last five years, rising by over 25%.
^DXY data by YCharts
Philip Morris International and Altria trade at nearly identical valuations relative to FCF/share, PM at 21.8x and MO at 21.6x.
Along with the high levels of free cash flow tobacco companies are known for, they also reward investors with high dividends from that FCF. Philip Morris currently yields 4.2%, while Altria yields 3.7%. However, I believe this alone is not a good reason to invest in Philip Morris, as I think this difference will converge relatively soon.
The chart below shows the dividend growth in the last five years, in which Philip Morris has outperformed in giving its shareholders annual raises.
PM Dividends Paid (TTM) data by YCharts
A three-year chart tells a different story.
PM Dividends Paid (TTM) data by YCharts
I see this trend continuing for a few years due to constraints on earnings out of Philip Morris. In the last twelve months, Philip Morris' payout ratio was over 90%, rising dramatically in the last few years. On the contrary, Altria's dividend payout ratio is around 81%, and has remained relatively stable in recent years.
While Philip Morris is perfectly capable of paying out over 100% of earnings because earnings, of course, are different than cash flow, I don't see management likely to go much above just to keep growing their dividend. The most recent rise was from $1.00 quarterly to $1.02 quarterly, or 2%. Altria notched growth of 8.7% in its last raise from $0.52 to $0.565 quarterly.
This trend does not have to continue long before Philip Morris' dividend yield premium falls to Altria's level.
In conclusion, I do not see reason for upgrading Philip Morris and downgrading Altria if one is to be making long-term investment.
Philip Morris may win out over the next year as losses from foreign currency exposure have not materialized as fully as investors were expecting. However, over the next five years, I see a different story.
Other major central banks have been on an aggressive path of easing as the United States has been tightening. Though the tightening has not been as fast as predicted six months ago, the long-term plan is to tighten, which could cause the dollar to rise. I don't believe one should sell or short Philip Morris at present time, but I believe Altria is the better buy for long-term investors making initial investment.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
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.