Phillip Morris International: Undervalued By 20% Or More

| About: Philip Morris (PM)

Why own any stock if it doesn't pay a dividend. While the S&P 500 and its tracking exchange traded fund, SPY, has rallied over 15% from the summer lows of last year, and market leaders such as Apple, have rallied nearly 30% this year, the recent sell-off has been brutal.

While the S&P 500 has sold-off around 8% in the last several months, market leaders such as GE (NYSE:GE), Caterpillar (NYSE:CAT), Citigroup (NYSE:C), and Exxon-Mobil have sold-off hard.

By far, the sector of stocks that held up the strongest during the recent sell-off has been dividend stocks.


While I've written several recent articles about how dividend stocks such as, Altria (NYSE:MO), Procter & Gamble (NYSE:PG), and AT&T (NYSE:T) are overvalued, I have consistently recommended investing in Altria and other tobacco and dividend stocks over the last several years.

Dividend and earnings growth are two sides of the same coin. If a company cannot consistently grow earnings and cash flow, the company will not realistically be able to rely on cheap capital to consistently raise its dividend over the long-term.

This is why I question the fact that Altria and Phillip Morris International (NYSE:PM), are trading at the same multiple today. To me this suggests that traditional consumer staple companies are moderately to significantly undervalued, while many higher growth companies, with significant exposure to Europe and most emerging markets, are moderately to significantly undervalued.

Phillip Morris International is a $145 billion dollar company trading at nearly 15x an average estimate of next year's likely earnings, that generates all of its revenue abroad.

Phillip Morris International gets nearly 28% of its revenue from the Euro-Zone, around 25% of its revenue from Eastern Europe and the Middle East, around 36-37% of its revenue from Asia, and just over 10% of its revenue from Latin America and Canada.


What's interesting about the company's latest earnings reports is that traders continually overestimate the effect that the Euro and the weakness in the European economy have on Phillip Morris International's business.

Phillip Morris International recently reported net revenue growth of 9.7%, 11% excluding currency translation. The company's EU business actually saw a 2.6% year-over-year gain in EU revenues, while volumes in this troubled economic region did drop 1.5%. Despite the Euro dropping nearly 20% from the first quarter of 2011 to the first quarter of 2012, the company's overall revenue growth was impacted by barely more than 1%. While the Euro has declined since the company's first quarter earnings were reported, Phillip Morris International has now guided to a 25 cent earnings per share forex effect, which resulted in the company lowering its guidance for 2012 by a little less than 2%, to $5.10-5.20 share.

Phillip Morris International's strongest growth was in Asia, where the company's revenue grew 19% year-over-year, driven mostly by strong market share gains in Japan. Revenue growth in Eastern Europe the Middle East and Africa was up around 9%, while revenue growth in Canada and Latin America was just .4%.

Now, to be sure, the company did benefit from some favorable industry trends during the last year, with its largest competitor in Japan, Japan Tobacco Inc., forced to temporarily halt cigarette shipments after the tsunami of last year. Still, Phillip Morris International's management team flew in specially chartered planes during the disaster, and the company has kept much of the market share that it gained last year.

Assuming Phillip Morris Internatonal's growth rate in Asia will likely slow, forex will impact about 1-2% of the company's revenues, and growth in other regions will likely be comparable to last year, the company should still be able to grow its earnings by about 6-7% this year, from around $4.88 a share last year to the $5.10-5.20 range management recently guided to just a couple weeks ago. Given the strong recent sell-off in the Euro, severe weakness in most emerging market economies, and the company's nearly 20% year-over-year revenue growth in Asia, 6-7% revenue growth would be impressive.

Also, looking at the severe recent weakness in major emerging market economies and the Euro-Zone, and the company's previous five year revenue growth of 11-12% a year, it is likely Phillip Morris International's future revenue growth will be around 10-11% a year over the next several years. The company has raised its dividend 55% since 2008, and management recently approved a new $18 billion dollar buyback plan over the next 3 years, with plans to buy back $6 billion in stock this year.

Nearly one third of the company's revenue is free cash flow, and management consistently returns just over 100% of its annual free cash flow by leveraging its balance sheet. However, while the company's debt to equity ratio of over 300% sounds high, Phillip Morris International has very stable revenue, and very strong coverage of its interest payments, at 13 times. The company also has a conservative payout ratio for the tobacco industry of around 60%, so management can use its strong borrowing power to increase shareholder value through acquisitions as well.

While company's growing at 10-12% are usually valued at around 14-15x forward earnings estimates, Phillip Morris Internatonal's consistent revenue growth even in the EU over the last several years suggests the company's products are not cyclical. Additionally, the company's extremely strong free cash flow enables management to leverage its balance sheet to maximize shareholder value through buybacks, dividends, and acquisitions. Management has also consistently bought back shares at good prices, with the company's recent buyback adding significant shareholder value.

To conclude, Phillip Morris international has shown it can consistently grow its revenue by double digits, and the 15 multiple is fairly conservative for a stock with double digit revenue growth that is not cyclical. Given that 30% of this company's revenue is free cash flow, the company's cost of capital is cheap and management can leverage the balance sheet significantly, Phillip Morris International's ability to payout 60% of its revenues in dividends while consistently growing at a double digit rate seems to justify a premium multiple. If you value this company at 17-18x next year's average earnings estimates, of $5.59 a share, the stock should trade at $100-105 a share.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.