By targeting inelastic demand and offering high dividend yields, tobacco provides perhaps the safest haven from double a dip. However, regulatory headwinds have some investors on the sidelines.
Philip Morris International (PM) confronts domestic regulatory headwinds by specializing entirely outside of the United States. In this article, I will run you through my DCF analysis on the firm and then triangulate the result with an exit multiple calculation and a review of the fundamentals compared to Altria (MO), which it was spun off from, and Reynolds American (RAI).
First, let's begin with an assumption about revenues. Philip Morris International [PMI] finished FY2011 with $76.3B in revenue, which represented a 12.8% gain off of the preceding year - acceleration. Analysts model 12% per annum growth over the next five years. I view this as overly conservative because PMI is targeting emerging markets, and when analysts are expecting around 10.6% per annum growth for the S&P500, a 12% estimate understates its potential. But, for the sake, of being safe, I accept the projection.
Moving onto the cost-side of the equation, there are several items to consider: operating expenses, capital expenditures, and taxes. I expect cost of goods sold to eat 74% of revenue versus 9.1% for SG&A and 1.1% for capex. Taxes are estimated at around 29% of adjusted EBIT.
We then need to subtract out net increases in working capital. I anticipate this figure to hover around 0.8% of working capital.
Taking a perpetual growth rate of 2.5% and discounting backwards by a WACC of 8.5% yields a fair value figure of $118.26, implying 37.3% upside. The WACC would have to be 10.4% for the firm to not appreciate, which is much too low given the firm's safety and low beta. This is on top of a 3.6% dividend yield.
All of this falls within the context of strong performance:
"We achieved global share growth for the fourth consecutive year, driven by our superior brand portfolio. Our solid volume performance, strong pricing and significant productivity savings led to record profitability. Finally and perhaps most importantly, we continued to generate strong cash flow, which enabled us to provide generous returns to our shareholders.
In the fourth quarter of 2011, we increased net revenues and adjusted operating company's income or OCI, excluding currency and acquisitions, by 8.2% and 7% respectively and grew our adjusted diluted earnings per share, excluding currency, by 13.4%".
From a multiples perspective, PMI trades at a respective 17.8x and 14.6x past and forward earnings versus 18.4x and 12.8x for Altria, and 17.2x and 12.9x for Reynolds American. Assuming a multiple of 17.5x and a conservative 2013 EPS of $5.77, the rough intrinsic value of PMI's stock is $109.63. In short, the bears who say this stock has reached its top are in for a big letdown -- especially in the event of a double dip.
Consensus estimates for Altria's EPS forecast that it will grow by 7.3% to $2.20 in 2012 and then by 7.3% and 5.9% over the next two years. Assuming a multiple of 15x and a conservative 2013 EPS of $2.31, the rough intrinsic value of the stock is $34.65. The company delivered strong performance in 2011 with adjusted diluted EPS growth of 7.9% and a shareholder return of 26.9%. With management repurchasing $1.3B shares, it has also showcased confidence over the free cash flow and the stock's future. The 8.3% per annum growth expectation by analysts has also likely set the bar a little low, allowing for greater-than-expected returns.
Consensus estimates for RAI's EPS are that it will grow by 11.6% to $2.78 and then by 6.8% and 6.7% more in the following two years, assuming a multiple of 16.5x and a conservative 2012 EPS of $2.91. Analysts are not too bullish on the marketer of Camel and Pall Mall, but I am optimistic about the firm's future in chewing tobacco. The $2.5B share repurchasing program has also demonstrated confidence over the fundamentals far beyond what the Street appreciates.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
Additional disclosure: The distributor of this research report, Gould Partners, manages Takeover Analyst and is not a licensed investment adviser or broker dealer. Investors are cautioned to perform their own due diligence.
