Imagine being able to borrow all the money you need at historically low rates.
That's the situation for investment grade debt. Philip Morris (PM) is taking full advantage of the low rates and refinancing its debt.
I don't think stock guys understand the profound implication of unloading its interest burden. Instead, they incorrectly focus on Philip Morris' high debt level. Take a peak at the bond world and you'll understand Philip Morris' sweet spot.
Here are the current rates of return Philip Morris pays on its bonds. 4.88%, 6.88% - there are some sky-high bond coupons out there. Ouch! These burdensome bonds are the legacy of the old high rate environment.
(Data from Finra)
I bet Philip Morris wishes it could call every bond and reissue them at today's rock-bottom rates!
Of course, it can't. They are all noncallable.
However, the bulk of its high-priced debt is front-end loaded and resets within 6 years. Almost every year a large chunk can get repackaged at a much lower rate.
Philip Morris gets to refinance at dream rates.
Look At These Dream Rates And Drool
Philip Morris just took advantage of that and replaced $2.25 billion with very attractive debt:
Nice.
You can get an idea of what rates Philip Morris could get right now floating debt by looking at the secondary bond market.
(Data from Finra)
Philip Morris CEO Louis Camilleri must be drooling. Putting the two together - coupon and secondary - you can see what he's seeing: a continual unwinding of high interest debt.
(click to enlarge)
(Data from Finra)
Next year, Philip gets to discard $2 billion of 5-year 4.88% debt. Consider Philip Morris doing another 5 year $2 billion debt offering which the secondary market already prices at 1.2%, giving it a $60 to $70 million savings every year.
In 2014, the company gets a crack at reducing $1.25 billion in debt priced at an even more whopping 6.88% coupon yield. If it refloated the loan for another 5 year term, it could save about $65 to 70 million a year at today's rates.
In other words, Philip Morris is entering debtor's heaven - everyone wants to lend it money at historically tiny rates. Currently bond investors need to go out 30 years to get returns that are greater than the stock's dividend yield. As the company takes advantage of these historic low levels, it will benefit the bottom line.
Of course, low rates won't last forever. Maybe, Philip Morris won't be able to refinance at such attractive levels when its debt comes due. Still, the Fed promises to keep rates low until 2014, making it likely Philip Morris can refi at very favorable rates.
Philip Morris is a beneficiary of the bond market's largesse, something that will help to push up share prices and ease Philip Morris' way to increasing dividends. Lower interest rates boost the bottom line.
This tobacco company is entering a debtor's paradise - a world in which it can refi at rock-bottom rates. Shareholders should invest in Philip Morris. You get a healthy 3.5% dividend yield likely to climb as Philip Morris' bottom line gets plumper.
Philip Morris is refinancing its high interest debt. Yet another reason to own the stock.
Disclosure: I am long PM.
Additional disclosure: The opinions in this document are for informational and educational purposes only and should not be construed as a recommendation to buy or sell the stocks mentioned. Past performance of the companies discussed may not continue and the companies may not achieve the earnings growth as predicted. The information in this document is believed to be accurate, but under no circumstances should a person act upon the information contained within. We do not recommend that anyone act upon any investment information without first consulting an investment advisor as to the suitability of such investments for his specific situation.
