Philip Morris (PM) has been one of the best value names in recent years, and continues to be an investor favorite due to its decent dividend and large share buybacks. The name is a leader in the industry, and should continue to be a great investment for years to come. Today, I'll discuss where things stand against the competition, and try to find a good entry point for those willing to get in. As I have in past articles, I'll use the following four names for comparison: Altria (MO), Reynolds American (RAI), Lorillard (LO), and British American Tobacco (BTI).
Part 1 - Where things stand now:
Second Quarter Results:
A couple of weeks ago, Philip Morris reported its fiscal second quarter earnings. Revenues came in at $8.1 billion, beating analyst estimates for just over $8 billion. Earnings per share came in at $1.36, beating estimates by a penny. Gross margins increased from 27% to 27.5%, and operating margins increased from 18.28% to 18.41%. Net profit margins stayed at 11.77%, due to an increase in the effective tax rate, and higher income from non-controlling interests.
The company reiterated its 2012 forecast for earnings per share of $5.10 to $5.20, which was taken down a few weeks prior due to unfavorable currency impacts. The company also reiterated its plan to buy back $6 billion worth of shares this year. The company has bought back $1.5 billion in each of the first two quarters, and also announced an expanded buyback during the quarter. The company currently is buying back a lot more shares than the other four names mentioned.
From here on, I'm going to compare where things stand to where they did a month ago, when I questioned if Philip Morris was still best of breed in this industry.
The first table I will present shows Philip Morris against the other four names, in terms of revenue and earnings growth, for 2012 and 2013. I have also computed a two year total, comparing 2013 to 2011. These are the current analyst estimates for each company's growth.
As you can see, Philip Morris is expected to show the second highest revenue growth over the two year period, and the third highest earnings per share growth. Lorillard remains first in both categories (with a tie in one).
But here is where things get better for Philip Morris. I've gone back to my article from a month ago, and compared where today's growth prospects stand. The following table shows the changes since then.
For instance, Philip Morris a month ago was expected to see 18.2% growth in earnings over the two years. Now that expectation is for 17.8%, a decline of 0.4% overall. As you can see from the chart above, Philip Morris is the only name not to have seen an overall cut in revenues. Analysts have taken down PM's 2012 revenue forecast, but have raised 2013's estimates.
On the bottom line changes, Philip Morris is in the middle of the pack, just behind Reynolds American. However, companies can always cut some costs here and there. Getting revenues has seemed to be an issue in the current macroeconomic environment. In my opinion, Philip Morris' growth prospects have become slightly more attractive, when compared to the other names, over the past month.
Valuations / Analyst Opinions:
When I look at the valuations of these names, I like to look at two metrics, price to sales and price to earnings. So I've collected the data for each, to determine both ratios for expected sales and earnings for this year (2012) and next (2013). The following table shows the valuations for each name.
With earnings expectations coming down slightly, and the stock rising a few dollars since my last article, PM's 2012 P/E ratio has increased by 0.54. Altria and Reynolds American have seen their P/E's rise by about 0.4, and the other two names have seen the P/E decline.
Philip Morris remains a bit expensive in relation to the other four, and has become slightly more expensive over the past month. However, since the stock is staying at or around $90, investors are proving that they are willing to pay a premium for this name. In the next part of my article, I'll discuss a few methods used to find an entry price.
Part 2 - Finding an entry price:
I still believe that Philip Morris is a great stock to own for the long term, but as I've stated in the past, it's not wise to buy at elevated levels. I've advised to buy this name on pull backs, and I'm reiterating that stance today. It doesn't seem like much to buy at $88 versus $90 when you are investing for the long term, but trust me, it adds up in the end. So here are a few ways to determine a decent entry price.
Using the P/E method:
In my past articles, I have suggested entering the name in a range based on valuation. I've used 16 to 16.5 times expected 2012 earnings. Depending on when I wrote the article, the range varied based on the current forecast.
But since we are now in August, enough of 2012 has passed that I'm starting to look forward to next year. Thus, I will use a range based on next year's expected earnings, which today, stands at $5.75. The range I will use is 14.5 to 15 times 2013 earnings.
How did I come to this level? Well, I kinda did it Olympic style. Look back at the valuation table above, and take out the high and low P/E names for 2013 (PM and LO). You then get the three others (RAI, MO, BTI), which when averaged, come up with a P/E of 14.74. I'm not going to quibble about .01 here, so my midpoint is 14.75, and I add or subtract 0.25 to it. Now, I'm not just doing it this way because of the Olympics, but when you have a wide variety of names, taking out the high and low score, or value, tends to smooth things out.
Given that P/E range and the current expectation, this method says that the entry range is $83.38 to $86.25, with a midpoint of $84.815. That's roughly in line with past ranges I have given.
Using the Dividend Yield method:
Philip Morris currently pays a dividend of $0.77 per quarter, or $3.08 per share. Most investors, like myself, are expecting a raise sometime soon, but for now, we are using the current dividend. That gives a current annual yield of 3.42%.
So using this method, you figure out what annual yield to get into the name at, and figure out your price. For instance, a 3.5% annual yield would mean entry at $88, a 3.6% yield would be $85.56, a 3.7% yield would be $83.24, and a 3.75% yield would be $82.13. We can revisit this method if and when they raise the dividend, but for now, I would start entering at the 3.6% yield price, and maybe add more at each 0.05% after that.
Since Philip Morris hit $90 for the first time back in April, the stock has hit a series of highs, then had a pull back each time. There have been four "significant" pull backs, and I'm not counting any that were just a dollar or two. So here are the dates and prices involved, from high to low, along with the dollar value change and percentage change.
The average pull back was $5.91 in dollar terms, and 6.53% in percentage terms. Now, Philip Morris shares recently hit a 52-week high of $91.81. If you take the average pull back dollar and percentage move, you get an expected low of $85.81 to $85.90, with an average of $85.854.
Averaging the Three:
After figuring out all three methods, wouldn't it be nice to average them out? Well, I've done that in the following table.
The average of the three comes to $85.41, so you can use that, or any one of the others, as your approximate entry point.
Conclusion - Let's wrap this up:
Philip Morris is still going strong. The company reported a great quarter, beating analyst expectations on the top and bottom line. The stock pays a nice dividend, and is expected to buy back another $2.5 billion in stock the rest of the year ($3 billion in second half = $0.5 billion per month on average). The dividend is expected to be increased in the next few months. Lately, analysts have been taking down some of their growth forecasts on this industry, but Philip Morris has seen the least downward revisions.
The valuation is a little high right now, which is why I provided a few methods to determine an entry price when this name turns down. A natural pull back will come, and you should continue to use those downturns to add to your positions. This is a great name to be in now and for the future.