Edited by Marianna Avilkina
Philip Morris International Inc. (PM) is the world's second-largest tobacco company, operating in 180 countries across the world. PM owns seven prime international brands. One of them is Marlboro, which, by sales statistics, is the world's number one cigarette brand. Most of PM's tobacco, such as Benson & Hedges and L&M, is priced at mid-high and mid-low levels. However, Marlboro generates about 35% of the company's revenue. Philip Morris currently gets 30% of its revenue from the EU, which experienced a 10% cut in revenue for the last quarter. However, the stock is recession proof, as it keeps climbing higher and higher.
As of September 19, 2012, the PM stock was trading at about $92, with a 52-week range of $60.45-$93.60. It has a market cap of about $155 billion. The trailing twelve-month P/E ratio is 18.2, whereas the forward P/E ratio is 15.9. P/S and P/CF ratios stand at 5.0 and 16.9, respectively. The operating margin is 43.1%, while the net profit margin is 27.7%. The company has a high debt, low equity policy, as a debt/equity ratio of 137 is far above the market average of 15.9.
Philip Morris pays solid dividends. The trailing yield is 3.37%, whereas the forward yield stands at 3.71%. Upcoming quarterly dividends are expected to increase by 10% to $0.85 per share in Q4 2012. Over the last five years, the company has boosted the quarterly dividend by 85%. The five-year dividend history suggests that Philip Morris is a prime dividend payer.
PM has a 3-star rating from Morningstar. Out of four analysts covering the company, one has a "buy" rating as well as one has a "outperform" and two others - "hold" ratings. This is good reason to suppose that Wall Street holds positive, yet diverse, opinions about the company's future. The average five-year annualized growth forecast estimate is 11.10 %. What is the fair value of Philip Morris given the forecast estimates? We can determine PM's fair value using the discounted earnings plus equity model, as follows.
Discounted Earnings Plus Equity Model
This model is primarily used for estimating the returns from long-term projects. It is also frequently used to price fair-valued IPOs. The methodology is based on discounting the present value of the future earnings to the current period:
V = E0 + E1 /(1+r) + E2 /(1+r)2 + E3/(1+r)3 + E4/(1+r)4 + E5/(1+r)5 + Disposal Value
V = E0 + E0 (1+g)/(1+r) + E0(1+g)2/(1+r)2 + … + E0(1+g)5/(1+r)5 + E0(1+g)5/[r(1+r)5]
The earnings after the last period act as a perpetuity that creates regular earnings:
Disposal Value = D = E0(1+g)5/[r(1+r)5] = E5 / r
While this formula might look intimidating for many of us, it easily calculates the fair value of a stock. All we need is the current-period earnings, earnings growth estimate, and the discount rate. To be as objective as possible, I use Morningstar data for my growth estimates. You can set these parameters as you wish, according to your own diligence.
Historically, the average return of the DJI has been around 11% (including dividends). Therefore, I will use 11% as my discount rate. In order to smooth the results, I will also take the average of ttm EPS along with the mean EPS estimate for the next year.
E0 = EPS = ($5.04 + $5.76) / 2 = $5.40
Wall Street holds diverse opinions on the company's future. While analysts tend to impose subjective opinions on their estimates, the average analyst estimate is a good starting point. Average five-year growth forecast is 11.10%. Book value per share is negative. The rest is as follows:
Fair Value Estimator
Fair Value Range
(You can download FED+ Fair Value Estimator, here.)
I decided to add the book value per share, so that we can distinguish between a low-debt and debt-loaded company. The lower boundary does not include the book value. According to my 5-year discounted-earnings-plus-book-value model, the fair-value range for PM is between $81 and $82 per share. At a price of about $92, PM is at least 10% premium over the fair value.
While there are many companies in the tobacco industry, British American Tobacco (BTI) is probably the closest competitor of PM. My FED+ valuation suggests that BTI is trading at least 30% premium over the fair value. However, unlike PM, BTI has relatively minor debt issues.
British American Tobacco also pays dividends twice a year. By contrast, PM has been remaining a steadfast dividend payer, which follows quarterly dividend policy. While both companies offer respectable dividends, Philip Morris currently does have a substantially better outlook in terms of dividend stability.
Return on Equity
Another competitor, slightly overpriced Altria Group (MO), is trading at least 2% premium over the fair value. The stock has a relatively strong forward dividend yield of 5.3%. However, similar to PM, MO seems to be exceedingly aggressive in financing its growth with debt. This strategy can result in poor protection of shareholders' interests against a business decline.
Current Economic Outlook
Phillip Morris has shown consistent weakness in Europe and the EU over the past year. The company has been particularly hurt by tobacco advertising display bans that are being adopted by countries. Norway and Australia were the most recent to adopt the ban. The ban bars PM from distinguishing its product, as cigarette manufacturers are required to sell their products in plain packaging. However, this is off-set by strong sales in Asia, where Philip Morris registered a 20% growth.
Philip Morris has been facing trouble with sales in Europe for the past few years. Notably, restrictions and deterrents of advertising by governments and health agencies have been forcing the company to seek new avenues of sales and revenue.
Nevertheless, the company's increasing dividends make it an attractive buy for the dividend-growth investors. Of course, there are inherent risks in investing in a tobacco company. There is always the possibility of lawsuits and change in people's habits.
The long-term earnings still remain in question and cannot be relied upon, especially as more and more countries adopt anti-tobacco campaigns. However, I think the governments around the world do not have any intention to interfere with the tobacco companies, as it provides a major source of tax for them.
The only thing that concerns me is the overvaluation issue. Based on my FED+ model, the PM stock is at least 10% overpriced. Therefore, although I think the company has great upside potential, I would recommend investors wait for a fair entry point below $82.