Is Philip Morris Still Best Of Breed?

| About: Philip Morris (PM)

Back in November, I called Philip Morris International Inc. (NYSE:PM) the best value in tobacco stocks. At that time, the company boasted a fair valuation and had a very good dividend. Philip Morris led the industry in trailing twelve-month margins, was expected to show a fair amount of growth going forward, and had the financial flexibility to buy back plenty of stock, which it was doing.

I gave another brief update on the tobacco industry in February, reiterating why I believed the name should be in your portfolio. My last update on Philip Morris came just a few weeks ago, when the company announced another round of news that was very pleasing to current and future investors.

Since November, Philip Morris has had a very good run, as you can see from the chart below. Philip Morris, in blue, has been the second best performer overall, second only to Altria (NYSE:MO), but has been in the top spot for a fair amount of time. The stock is up about 29% since then (adjusted for dividends), and has gained 36% in the past year. The question is, is it still the best name in the industry?

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Source: Yahoo! Finance

So yes, let's look at where these five names stand. The three I haven't mentioned so far are Lorillard (NYSE:LO), Reynolds American (NYSE:RAI), and British American Tobacco (NYSEMKT:BTI). I've used these five in past articles, so it only makes sense to be consistent and use them again.

First, I will look at the current dividends, which is probably what most investors in these names care about the most. The following table shows the last paid dividend, and that number annualized and the current yield. British American pays a dividend twice a year, with the first payment being higher than the second usually. For that company, the annual value below is the total of the last two payments.

Dividends PM LO MO RAI BTI
Last Paid $0.77 $1.55 $0.41 $0.59 $2.78
Annual $3.08 $6.20 $1.64 $2.36 $4.02
Yield 3.53% 4.70% 4.75% 5.26% 3.94%
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Philip Morris has the lowest yield at the moment, but it has paid that 77 cent dividend for four straight quarters. When it announces its next dividend in the next couple of months, most investors are expecting a raise. The current new dividend range (from what I've heard) is a range of 80 to 90 cents a quarter. That is a wide range, but let's take the midpoint of $0.85. That would be an annual dividend of $3.40, which would currently yield about 3.9%.

Now, there is the potential that Philip Morris raises it even more than that, given the number of shares it is buying back currently (thus reducing the outstanding share count). Remember, Philip Morris raised its dividend from $0.64 to $0.77 in 2011, so a raise to $0.90 might not be out of the question, and that would get the yield closer to the other names. But even a $0.90 quarterly dividend would still only be a yield of 4.12%, a bit below some of the other names.

Now the second thing we will look at is growth, in terms of both revenues and earnings. The following table will show the current expected growth (from analysts) for 2012 and 2013, as well as the two-year total (from 2011 to 2013). Now remember, Philip Morris took down its earnings forecast recently. The company announced a new earnings per share range of $5.10 to $5.20 for 2012. That's down a dime from the prior forecast, which makes sense since it said unfavorable currency changes will cost it $0.25 (the last update was a $0.15 impact).

2012 2.2% 5.4% 4.1% -0.5% 1.5%
2013 5.2% 5.9% 1.1% 0.9% 3.0%
Two-Year 7.4% 11.7% 5.2% 0.4% 4.5%
2012 6.1% 10.0% 7.3% 5.0% -13.3%
2013 11.4% 11.2% 7.3% 7.5% 37.9%
Two-Year 18.2% 22.3% 15.1% 12.8% 19.6%
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In terms of the two-year totals, Philip Morris comes in second in terms of expected revenue growth, and third in terms of earnings growth. Lorillard is in first place in both categories. Philip Morris, due to unfavorable currency fluctuations, has now seen potential earnings numbers come down in the past month. Analysts have taken down this year's number by a dime and next year's by 8 cents in the past month. Before those changes, the two-year expected number was at 19.9%.

So in terms of growth, Philip Morris is better than average, but it is not the top name at the moment. But growth is just one thing to look at. You also need to look at what you are paying for that growth. The following table shows the price to sales and price to earnings ratios for each, based on the current market cap and currently expected revenues and earnings for each.

Valuations PM LO MO RAI BTI
2012 P/S 4.68 3.67 4.06 3.02 3.99
2013 P/S 4.45 3.46 4.02 2.99 3.87
2012 P/E 16.85 15.22 15.70 15.21 18.88
2013 P/E 15.12 13.69 14.64 14.15 13.69
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Philip Morris is the most expensive on both valuation metrics, except for the 2012 price to earnings number. Philip Morris was at the higher end of the valuation range when I last updated in November as well. I wouldn't be too concerned at the moment, because Philip Morris isn't that much more expensive than the rest, but investors should know they are paying a premium. Now, if the 2013 price to sales were over 5, or the 2013 P/E was closer to 20 right now, then I might be worried. But this company has seemed to trade at a premium to the others for some time now. It is an investor favorite, and sometimes you pay a premium for that. It appears investors are willing to do so.

So far, you would say that Philip Morris is not the best of breed in this industry. The numbers would support that statement. So what does the company have going for it? Well, the first thing is top-tier margins.

Operating 43.55% 44.96% 40.05% 30.86% 33.93%
Profit 27.82% 24.49% 20.55% 15.27% 20.10%
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In terms of trailing twelve-month margins, Philip Morris is close to the top in operating, but maintains a significant lead in terms of profit margins. In fact, the profit margin lead (333 basis points) has increased since my November update (327 basis points). It is a small increase, but an increase is an increase.

But the other thing that makes Philip Morris such a great investment is the fact that the company is buying back so much more stock than the others currently. Right now, Philip Morris is buying back $1.5 billion of stock per quarter, and the company has bought back nearly $10 billion in the past two years. Philip Morris recently announced a new buyback program (see "very pleasing" link above).

Altria bought back just under $300 million in Q1, and might buy back even less in future quarters. Lorillard bought back less than $200 million in the quarter, which completed its buyback program, and no announcements have been made for future purchases. Reynolds American purchased $300 million worth of shares in Q1. British American bought back about $240 million worth of shares in Q1 (official numbers was 150 million, currency in pounds).

That means that the four companies combined purchased slightly more than $1 billion in shares during Q1. Philip Morris by itself bought back $1.5 billion, and plans to buy back that much each quarter in 2012. This is one of those reasons why investors are willing to pay a slight premium for shares, as I noted above.

Now I already showed you the potential growth prospects for these firms, according to street analysts. The final numbers I'll present today are the analyst opinions of each. This will include a rating (from 1 to 5, with 1 being a strong buy and 5 being a sell), as well as the average analyst price target, and the potential upside to that target from the stock's current price.

Rating 2.3 2.5 2.5 2.9 2.7
Target $90.88 $140.22 $33.36 $43.40 $111.80
Upside 4.15% 6.27% -3.44% -3.28% 9.48%
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The lowest rating number is the strongest buy, so Philip Morris is the favorite among analysts currently. A difference of 0.2 isn't that much, but it still means Philip Morris is the top pick. In terms of upside, Philip Morris is in the middle of the pack. Analysts still believe it can go higher, but not by a tremendous amount. Although most of these names have seen huge rallies in the past 6-12 months, most investors buy for value and not for growth. The near $91 price target makes sense for Philip Morris, as we tend to see analysts downgrade the name on valuation when it gets near $90.

So is Philip Morris still best of breed? Well, let's recap. The company has the highest margins in the industry and is buying back the most stock right now. Analysts like it the most, but don't see a ton of upside. Revenue and earnings growth is above average, but isn't the best of the five in this group. The valuation is more expensive than all of the others. The dividend, although expected to be increased in the next few months, is at the bottom in terms of yield.

So overall, Philip Morris remains a strong investment, and I still consider it above average for this industry. However, the recent earnings guidance take-down concerns me slightly, and the name doesn't lead in as many categories as it did in November. Thus, I'm not going to say it is the best of breed right now, but I still think it is in the general discussion for a top pick in the industry.

I will reconsider my stance once we see the next round of earnings and the potential dividend increase. For now, I am still recommending a good entry point between 16 and 16.5 times this year's earnings (we are now at 16.85 times). That gives you an entry price range of $82.88 to $85.47, with an approximate midpoint of $84.18. Generally speaking, $84 has been a good level of support for the name in recent months.

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