Philip Morris International: 20% Overvalued

Oct. 4.12 | About: Philip Morris (PM)

Price action and fundamentals are not always aligned. When stocks go up, markets are usually pricing in stronger earnings expectations, but short-term price action and long-term fundamentals vary.

Philip Morris International (NYSE:PM) is a nearly $157 billion dollar company selling cigarettes in nearly 160 countries. The company sells no cigarettes in the U.S., unlike its peer, Altria (NYSE:MO). Phillip Morris International trades at nearly 18.5x trailing earnings estimates, and nearly 16x forward earnings estimates. The company's profit margin is 27%, and its operating margin is 43%. Philip Morris International has a poor debt to equity ratio of over 300, and the company has $20 billion in long-term debt, but management also has strong coverage of interest payments at 13x, and Philip Morris International has been able to recently raise capital at less than 4%. The stock hit a 52 week high today.


Philip Morris International gets 40% of its revenues from the EU, 40% from Asia, around 8% from Eastern Europe, the Middle East and Africa, and nearly 12% from Latin America and Canada. The company's strongest growth over the last several years has been in Japan, the Philippines, Turkey, and Russia. The company's revenues in the EU have fallen significantly, with EU revenues declining nearly 10% last quarter.

Philip Morris International has risen over 50% in the last year, even as Europe has weakened and the euro has fallen. The company's strong recent growth in Asia has more than offset EU weakness, but this past quarter, the company reported negative growth in Asia, and also discussed the possibility of new and significant taxes being imposed by the Japanese and Philippines governments. The company also reported a significant slowdown in the EU, and flat revenues in Latin America and Canada.

Philip Morris International continues to reiterate its currency neutral growth target of 10-12% a year over the long-term, but this goal is not realistic. The company is already buying back $6 billion in shares a year, and the current 10-12% growth rate it has had over the last year has only been possible because of the buy back, providing significant shareholder value since the shares are up over 50% in the last year. The company's current organic growth rate is closer to 8%, and even this growth is unsustainable. Philip Morris International has been able to raise prices to offset market share losses in the EU, and the company's revenues in continental Europe only declined 2% over the last year.

This past quarter, the company's EU revenues declined by double digits, with cigarette volumes dropping by 10% in Italy and 5% in Germany. Most of the company's market share gains in Eastern Europe were with its lower end brands, such as L&M. The company's revenue growth in Asia is also weakening. Philip Morris International's revenue growth in Asia has almost exclusively come in Japan, but the Japanese market has become much more competitive in the last several quarters, and economic data in Japan continues to weaken. This past quarter, the company reported modestly negative growth in Japan of 2%, with market share losses in this country.

Philip Morris reaffirmed its guidance of $5.10-5.20 earnings per share, and the company also reiterated its 8% growth target, but management's growth projections are overly optimistic. Shares have risen over the last month as the Euro has increased nearly 10% against the dollar, and equity markets have continued to rally on stimulus hopes. Philip Morris' 8% growth target is ridiculous, and management has not lowered its guidance for 2012, even as cigarette volumes continue to decline by double digits in Europe, and the company's growth in Asia has stalled. The euro has risen significantly in the last month, but currencies are volatile, and EU and Asian growth projections continue to fall.

To conclude, if Philip Morris's real growth rate slows to 4-6% over the next several years, the stock will trade at 12-14x forward earnings, and the company's significant debt will make future dividend raises difficult. Europe and Asia also continue to slow significantly. If the company earns $5.15 a share this year, the stock will likely trade at $75-80 a share if growth slows to mid-single digits.

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.