A recent article about Philip Morris (PM) caught our attention. It talks about the stock being overvalued by 20%. This article is presented to counter the points presented in the original article, with all due respects to the author "Skeptical12".
The article linked above states/hints the following about why PM is overvalued. Let's list them one by one and provide counter points.
- Shares hit a 52 week high and have risen over 50% from last year - Sure, the stock has gone up from the $60s level in October 2011 to its present high of $94. But so has the entire market. The exact bottom for most stocks was hit on October 4th of 2011 before the market rebounded violently. So, when Dow Jones, for example has gone up 30% from the October 2011 lows, why should a leader like Philip Morris not go up 50%. Oh, wait, the 50% increase has not just been because of some irrational buying frenzy. It has been backed up by two very important factors: earnings and dividends.
The earnings per share have gone up in the past year from the October 2011 lows.
Also, the dividend was increased about 10% recently, which obviously pulled more buyers in as the yield is close to 4%.
- Euro concerns on earnings: This is certainly an issue for all the companies with European exposure. But like "Skeptical12" has acknowledged, PM gets a huge chunk of its earnings from Asia. Passing issues like dollar conversion should not be a big concern for long term investors. PM benefited from a weaker dollar in 2011 and obviously a stronger dollar would hurt. And in spite of the euro concerns, look at how the company has fared in its earnings. Remember, a stock goes up or down depending on how its earnings are with respect to expectations. PM has a long history of beating the expectations.
- Slowing Growth: "Skeptical12" makes an assumption that PM's earnings growth will slow down to 4 to 6% over the next several years. But the expected 5 year growth rate is close to 10%. Sure, it might not be that high throughout. But companies like PM definitely know how to make the investors happy. A reduced demand (if any) can definitely be compensated by: increasing the price, reducing cost, buying back shares (which the author acknowledged.) Altria (MO), Philip Morris' parent, turned out to be a pile of gold for investors not by being a tremendous growth stock but by being one with a focus on enhancing shareholder returns.
As indicated in an earlier article, sadly 2/3rds of men smoke in Indonesia, one of the biggest markets for PM. PM has already found success here and owns about 33% of the market. With its strong brand image, PM could get deeper in Indonesia and other countries. The World Health Organization [WHO] reports 80% of the world's one billion smokers live in middle and low income countries. It's these countries where PM and the likes will seek the growth. On humanitarian grounds, it's sad but if you keep investment thesis separate from your ethics there is enough to believe the stock will do alright.
Also, the original article notes that PM's management has not reduced its guidance for 2012. That is actually good for investors. Doesn't that mean the management has something up its sleeve (reducing cost?) to make sure earnings are good even if the demand slows up?
- Valuation: This was not directly mentioned in the original article but stocks like PM and British American Tobacco (BTI) carry a higher PE when compared to stocks like MO and Lorillard (LO) because of higher penetration expected in the foreign market.
Conclusion: PM, like any stock is prone to profit taking when the market is making daily highs. But that does not make the stock overvalued by any means. The shares have grown along with the rest of the market, increased earnings and an ever increasing dividend.
Disclosure: I am long PM.