Philip Morris: Where Trouble Lies

| About: Philip Morris (PM)

Summary

Company reduced 2016 EPS due to currency hit.

Dollar strength continues to make situation worse.

Rising rates and tough comps make 2017 look scary.

A couple of weeks ago, I wondered if we were going to see a 5% annual dividend yield for cigarette giant Philip Morris (NYSE:PM) rather soon. A stronger dollar and rising US interest rates provide a one-two punch that negatively impacts results. Recently, the dividend yield nearly hit 4.80%, and that number could get even higher if the current post-election market trend continues.

When the company presented at a consumer conference last week, management took down its guidance for the year as seen on these slides. Unfavorable currency movements will hurt EPS by 42 cents per share, up from 35 cents previously. Unfortunately, the US dollar has continued to rise since then, as seen in the chart below:

(Source: CNBC.com)

The recent rise in the Dollar Currency Index towards 102 isn't just a problem for the end of this year. Should the DCI hold at these levels, or even decline slightly, it makes the middle part of 2017 tough for Philip Morris as seen in the chart above. While the company does have a hedging program and can raise prices in certain cases, it usually can't combat all of this currency issue, meaning next year's earnings will likely see another hit.

Another decline in net earnings also likely impacts the company's cash flow, which is critical for capital returns. Given the dollar's strength recently, there is virtually no chance that we see the share repurchase plan restarted any time soon. Future dividend raises also come into question since the company already pays out almost all of its free cash flow to shareholders.

The other problem is that US interest rates continue to rise, with the 10-Year Treasury up about 25 basis points since my previous article. Not only do rising rates make dividend stocks less attractive, but it means Philip Morris is not in a great position with its $25 billion net debt position. In the table below, you can see the company's debt issuances that have maturities within the next year. Given the low rates for the US dollar debts, the company is likely to pay more when it refinances, meaning lower earnings and worse cash flow.

(Source: Philip Morris fixed income page)

As a follow up to my prior article, the chances of Philip Morris' shares reaching a 5.00% annual yield have increased in recent weeks. The US dollar's strength is going to hurt earnings this year and next while rising rates will cause debt refinancing to be more expensive. Should the Federal Reserve raise rates at its upcoming meeting, the market's recent trend is likely to continue, and that's bad news for Philip Morris.

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