Philip Morris International (PM) recently reported mixed Q3 results and its $0.01 miss of consensus contributed to a 4.8% share price decline. The company has been a consistent performance for a long time and had last missed the consensus EPS two years ago in 3Q10. While the weakness is not a surprise for a company that has so consistently delivered over time, I see no change to the thesis, and see a buying opportunity.
I think the bigger factor was the company's ability to generate 4.5% adjusted OCI growth (excluding FX) despite extremely difficult (+23%) year ago comparisons, with Asia notably posting 1.2% OCI growth on top of last year's 75% growth (90% including FX). I think that Philip Morris' fundamental strengths in EEMA (once again the bright spot in 3Q) and Asia (masked in 3Q by a very demanding comparison base) remain very much intact.
Continued Strength in EEMA
Philip Morris' EEMA results were the standout in the quarter, as the company posted 11.3% operating income growth in the region despite currency headwinds. The strong results were driven by higher pricing and favourable mix. Despite the strong showing in EEMA, investors may be somewhat concerned given the uncertainty surrounding the upcoming regulatory and taxation changes in Russia. However, I think tax increase in Russia could actually be a positive as the likely pass-along price increase to the consumer from next year's tax increase would be in line with this year's increase, which has not hurt volumes (up 4.8% YTD). Moreover, tax-driven price increases would narrow price gaps and will likely benefit Philip Morris' premium brands.
Asia Results Impressive Given Tough Comparisons
Despite challenging year ago comparisons in Asia, Philip Morris posted 0.6% volume growth and 0.5% EBIT growth in the region in 3Q12. Clearly Q3 was the most difficult comparison of the year, particularly with Asia facing a +90% year ago OCI growth (+75% ex-FX). However, the OCI growth comparisons ease considerably (particularly in Asia) moving into Q4.
OCI % growth
I expect Asia to continue to be a driver of both sales and operating income growth for Philip Morris. In much of Asia, younger consumers favour foreign brands and thus, I see an advantage for Marlboro as a foreign brand. Moreover, Philip Morris' portfolio is broader than it was 2-3 years ago, meeting a wider range of consumer preferences.
In Korea, the company has recovered market share lost when it took pricing, and is sequentially gaining share. A tax (and price) hike could come in 1H13 (after elections there). Price hikes would be beneficial to Philip Morris as it narrows price gaps, which can help drive share gains (and help margins).
The company also has white-space opportunities in India & Vietnam. Though the company faces stiff competition in India (from ITC), I see a long term growth opportunity there. On the other hand, Vietnam has already emerged as a growth contributor for Marlboro in Asia. The macroeconomic environment is good in Vietnam and Philip Morris has a structure in place. Philip Morris has already captured more than 15% of the market share (vs. about 2% nationally) in Hanoi (1 of 6 focus cities); showing what the company's potential could be.
Share Repurchase Will Provide Support
The company repurchased $1.5 billion in shares in the quarter, as expected. The company recent started executing its 3-year, $18 billion share repurchase authorization and I expect $6 billion of share repurchase in FY12 which is supported by strong free cash flow generation.
Dividend and Valuation
Over the last 3 years, Philip Morris has paid substantial dividends to the share holders and the company continues to offer an attractive forward dividend yield of 3.90%. Let's analyze the dividend yield of Philip Morris and other tobacco companies including Lorillard (LO), Altria Group (MO) and Reynolds American (RAI).
We can see that although Philip Morris has the lowest dividend yield among these tobacco companies, it also has the lowest payout ratio. In addition to Philip Morris, Lorillard also seems to have hit the right balance between dividend yield and payout ratio. On the other hand, Reynolds American and Altria Group's high dividend yield comes at the expense of high payout ratio and thus, causes some concerns over its sustainability.
Let's analyze the valuation multiples like forward P/E and PEG ratio of these tobacco companies.
Source: Yahoo Finance
Philip Morris might look relatively expensive on a forward P/E basis, but it has a higher growth rate to support its higher multiple. PEG ratio is a better indicator of a stock's true value and Philip Morris looks attractively priced on a PEG basis. Lorillard also looks like a good bet at current levels. However, both Reynolds American and Altria Group appear overvalued.
To sum up, I think the recent weakness in Philip Morris shares provides a good entry point. The company offers a good dividend yield and the stock looks impressive from a valuation standpoint. I believe Philip Morris' pricing power (+4.8%) remains intact and earnings should rebound in Q4 and 2013. Thus, I recommend buying this stock.