Philip Morris (PM) holds a 16% share of the international cigarette market outside the U.S. with its products being sold to over 180 countries. Since the spin-off, it has been dispersing huge amounts of cash to its shareholders, and analysts expect steady increases in cash flows. Given its relatively high expected growth rates and leadership position in several markets, we recommend the stock as a buy.
Reported revenues were down by 1.8 % for the quarter. However a comparison of the quarter with last year's quarter is not meaningful, since the last year saw a hike in sales (Graph 1) owing to the loss of competition from Japan Tobacco in the Japanese market. Last year, PM experienced a surprise volume increase of additional 6.3 billion units shipments to Japan, since the tsunami reduced PM's rivals' competitive power. Viewed in that context, the quarter doesn't seem all that bad. Furthermore, PM reaffirmed its guidance for the full year reported diluted EPS in the range of $5.1-$5.2, up from $4.85 in 2011. The European Union saw a fall in net revenue of 8.5 %, EEMA registered an increase of 6.9 %, Asia witnessed a decline of 2.8 % and Latin America & Canada managed to increase net revenue by 0.1%. By excluding currency headwinds and acquisitions, net revenues increased by 2.9%. Currency issues have always been part of international operations and the current headwinds could turn into tailwinds.
Dividend Stock Analysis
Since 2008, after the spinoff of Altria Groups international division, in an effort to bar its international operation from U.S. litigation risk, PM has been steadily increasing dividends (Graph 2). According to the last annual report, PM has managed to bring about an increase of 67.4% in dividends. We forecast substantial space for further increases given the solid performance that is expected in the coming years. Analysts expect a long term earnings growth rate of 9.71 %. Additionally, mean EPS is estimated at $5.18 for the full year ending 2012 and $5.76 for the following year, which translates into a growth rate of 11.2%. On a comparable basis, Altria's (MO) and Lorillard Inc (LO)'s growth rate is expected to be 7.7 % and 9.7 %.
Like any tobacco company, PM possesses important leverage for price increases, which are often employed to counter falling demand for the addictive product over time. EPS (Graph 3) for the company has increased, brought about by strong brand recognition, acquisitions and cost reduction initiatives. It has a target of $300mn in gross productivity and cost savings for 2012.
Gross margins have slowly increased since 2010 as well:
Although the company has been generating healthy cash flows (Chart 4) and its capital expenditures have been minimal, the company has been dispersing cash at a rapid pace, and consequently, its total cash distributed to shareholders (in the form of dividends and share repurchases) exceeded its free cash flows. However, analysts expect FCF to reach $11b by the end of 2013. Certainly, a corollary of this is a rise in the debt levels, but a current interest coverage ratio of 14x does not raise any doubts on its ability to make good on its debt. Unless, the company faces serious troubles, the company will continue on its path of dividends increases, as it has done since the spinoff. Beginning in May 2008, PM has bought back $24.4b worth of its share, which means 21.3 % of total shares outstanding at the time of the spinoff. For the second quarter of 2012, PM spent a total of $1.5b to repurchase 17.8 million shares. The company has initiated a new repurchase program worth $18b. Target for the repurchase program in 2012 is $6b, representing 4% of the current market cap.
Reynolds American Inc (RAI)
British American Tobacco PLC (BTI)
Based on price of cash flow multiple's comparison with the industry average, the stock seems fairly valued at the moment. P/E multiple also highlights the same picture. Growth seems solid compared to its competitors:
PM shows the largest potential for EPS increases of 11.2% from the year ending 2012 to 2013. LO is expected to increase by 9.7% for the same period, followed by 7.7% of MO. Multiples could shrink should the litigation environment tighten its hold, as the recent plain packaging legislation in Australia. Although other nations still have to adopt such legislation, it nonetheless remains a threat. The stock is trading at just 4.7 % below its 52-week high, but given its high expected growth rate and strong leadership in a number of markets, we believe the multiples are justified and recommend the stock as a buy.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.