Philip Morris Offers Impressive Income Growth

Sep.23.12 | About: Philip Morris (PM)

Edited By Adam Isaac

Philip Morris (NYSE:PM) is one of largest tobacco companies in the world. The company manufactures seven of the 15 top international brands, including Marlboro, which is the number one cigarette brand worldwide. Philip Morris sells its products in almost 180 countries. At the end of 2011, the company held about 16.0% share of the total international cigarette market outside of the U.S., or 28.1% excluding the People's Republic of China and the U.S.

In my previous article, I talked about the dividend stability of Philip Morris, where I looked at the earnings, cash flows and balance sheet of the company. In this article, I have calculated the profitability, leverage and cash flow metrics which can show the trends in the financial situation of the company over the past three years. For the analysis, annual reports were used to gather data which can be found here.

Profitability Measures:

2011

2010

2009

Gross Profit Margin

26.75%

25.84%

25.79%

Operating Profit Margin

17.46%

16.54%

16.17%

Pre-Tax Profit Margin

16.41%

15.25%

14.89%

Net Profit Margin

11.63%

11.07%

10.55%

ROA

25.02%

21.39%

18.96%

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Over the past three years, the firm has improved its profitability. All of the measures indicate a positive trend in the earnings of the firm. Over the three years, the firm was able to increase its gross profit margin by almost 1%. Overall world economy has been in turmoil over the past four years; still the firm was able to increase its profit margins.

The tobacco industry is a mature industry, where achieving heavy margins or a large increase in margins can be a tough task. However, the firm has been able to increase its operating profit margin by 1.29% and pre-tax profit margin by 1.52%. In addition, net profit margin has also shown a positive trend and currently stands at 11.63% as compared to 10.55% at the end of 2009. Furthermore, ROA for the firm has jumped up by 6.06% over the previous three years. Overall, Philip Morris is demonstrating healthy profitability trends and stable margins.

Leverage Measures:

2011

2010

2009

Debt Ratio

52.26%

47.08%

44.62%

Capitalization

97.11%

80.75%

71.50%

Interest Coverage

16.67

12.79

12.60

Cash Flow to Debt

0.57

0.57

0.51

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In order to assess the leverage situation of the firm, I have used four ratios. Over the past three years, debt as a ratio of its total assets has been gradually increasing. At the moment, debt as a ratio of total assets stands at 52.26%. There has been an increase of over $3 billion in total debt of the company, while total assets have only increased by $936 million.

However, an increase in the capitalization ratio is due to the decrease in the common equity of the firm. Philip Morris has been repurchasing shares gradually, and over the last three years, the company has bought back stocks worth almost $16 billion.

Interest coverage ratio is exceptionally strong for Philip Morris, and it should not have any trouble in paying its debt and interest obligations. In addition, the firm is generating cash flows more than half of its total debt as indicated by the ratio. Overall, I believe the firm can easily tackle its debt levels and should not have any trouble covering the interest expenses.

Cash Flow Measures:

2011

2010

2009

Operating Cash Flow to Sales

13.79%

13.94%

12.70%

Free Cash Flow to Operating Cash Flow

91.48%

92.44%

90.93%

Capital Expenditure Coverage

11.74

13.24

11.03

Dividend Coverage

2.20

2.13

1.82

CAPEX + Dividends Coverage

1.85

1.84

1.56

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Philip Morris generates healthy cash flows, in 2011, operating cash flows for the firm stood over $10 billion. Operating cash flows to sales ratio for Philip Morris has increased by 1.09% from the levels of 2009

Free cash flow ratio of over 90% indicated that the firm has not been investing much in capital expenditures. In fact, the firm spent less than one billion dollars on capital expenditures in any of the previous three years.

Capital expenditures increased from $715 million in 2009 to $897 million in 2011. As a result of high operating cash flows and small capital expenditures, the capital expenditure coverage ratio is quite high. In addition, the dividend coverage and dividends combined with CAPEX indicate that the firm is generating enough cash flows to meet its dividend and capital expenditure needs.

Summary:

Philip Morris is truly an international brand, which has its presence all over the world. It is evident from my analysis that the firm is in a strong financial position. Almost all of the measures indicate that the firm is on the right track and the profitability of the firm is improving. While some of the company's more mature markets are experiencing lower cigarette demand, I expect that the company's Asian operations will continue to steer the company towards the future growth. There are still growth opportunities in the developing economies. A strong financial position should set up Philip Morris nicely to exploit those growth opportunities. While I think Phillip Morris is a bit overvalued at the moment, the stock offers solid growth opportunities.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.