Recent Sell-Off In Philip Morris Makes Great Buying Opportunity

| About: Philip Morris (PM)

Has anyone seen the recent sell-off in Philip Morris (NYSE:PM)? Shares of the tobacco maker are nearly $7 off their 52-week high, which was set just two weeks ago on January 3rd. This is a noticeable decline for a name that's normally considered a safety investment, a lower beta name that's usually bought for its hefty dividend. Why has the name dropped so much? Well, there are two reasons. First, there have been a couple of analyst downgrades, based on the nearly $15 run up the stock had to $80 in the past 3 months. The stock was due for a little profit taking, and I'm not surprised about the downgrades.

First, here's what the analysts have said. Citigroup lowered their earnings estimates on the name, and they currently have a neutral rating with a $75 price target. Goldman Sachs lowered the name from a buy to a neutral, but they still have an $80 target on the company. Just last week, Bank of America analysts put an $85 target on the name. There was another downgrade earlier in the month, when Davenport downgraded from buy to neutral. But that was $5 ago.

I initiated a position in the name during Wednesday's decline, as I felt that the drop was overdone and the yield has become more attractive. Here are the key reasons why this stock is still a buy.

1. Company has an impressive dividend yield, which has now increased nicely in the past 2 weeks:

Just two weeks ago, at the high point for the stock, the company was yielding 3.85%. Normally, that's a great dividend. However, we are now yielding 4.2% in the name, a 35 basis point increase in just two weeks.

The company has also increased its dividend nicely since its spinoff a few years ago. The past two increases have been from 58 cents to 64 cents to today's 77 cents per quarter. I'd expect that number to be raised again, which probably will be in the second half of the year. Given even just a few pennies per quarter increase, the dividend you'll get in the next year protects you down to $70 in the name. If you want even more protection, there's a variety of option strategies you could use to increase your protection, but I don't have a recommendation for one currently. I'm just long the stock.

2. The company is actively buying back stock, and lots of it:

If you are worried about further downside in the name, it may be limited. This company continues to buy back its own stock, and in large quantities. In the third quarter of 2011, they bought back 21.2 million shares. That's $1.4 billion worth of stock, and they've bought back similar amounts in past quarters. The buybacks will continue, and that will help the stock going forward. They are buying back about 3.5 days of normal volume in the stock per quarter.

3. Comparisons to competition:

When I say the competition for Philip Morris, there are four other major cigarette names I focus on: Altria (NYSE:MO), Lorillard (NYSE:LO), Reynolds American (NYSE:RAI), and British American (NYSEMKT:BTI). All four names have forward P/E values in the 13.2 to 14.1 range, so there is no overwhelmingly cheap or expensive stock. In fact, if you look at the price to expected growth ratio (for the next 5 years), Philip Morris' comes in at 1.25, which is the cheapest. The other four names come in between 1.39 and 2.50.

In terms of margins, Philip Morris has the 2nd highest operating margin, just 55 basis points behind Lorillard (trailing twelve months), and Philip Morris has much higher gross margins than Lorillard. When you get to the bottom line, Philip Morris dominates. The following table shows how the company has much higher profit margins and return on equity numbers than the other names.

Margin 27.76% 21.16% 21.46% 24.49% 15.61%
ROE 178.87% 72.12% 39.34% N/A 19.98%


If you ask around for a good value pick, Philip Morris will be on mostly everyone list. It's on mine, and I bought some today thanks to the steep decline. While a number of analysts have downgraded it on valuation recently, it's come nearly $7 off its high. The yield has jumped 35 basis points in just two weeks. I'll take a 4.2% yield, which is well above US treasury bonds. Despite the recent downgrades, the overall analyst recommendation is a buy, and the $78 plus average price target is still $5 north of current levels. Add in $3 a year of dividends, and this stock seems good to me. It's been down lately, but I think the sell-off provides a great entry point.

Disclosure: I am long PM.

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