Philip Morris Headed Higher - 3 Reasons Why

| About: Philip Morris (PM)


Philip Morris’ high yield indicates that it offers upside potential given the high demand for robust dividend stocks among income-seeking investors.

Its international exposure could cause a boost to both volumes and price increases across the emerging world.

Its marketing and investment in reduced risk products (RRPs) could boost sales and earnings moving forward.

In the last year, shares in Philip Morris (NYSE: PM) have risen by 20%. That's 18% higher than the S&P 500 has managed during the same time period and in our view, further outperformance lies ahead for Philip Morris. In fact, we think that there are three key catalysts which will push its share price higher.

The first of those is its income appeal. Philip Morris currently yields 3.9% while the S&P 500 has a yield of just 2.1%. We feel that there is a considerable mismatch at play here in terms of Philip Morris offering excellent income appeal which is likely to remain highly attractive even as interest rates rise.

Comparing it to other tobacco companies such as Altria (NYSE:MO) and Reynolds (NYSE:RAI) strengthens our case further, with those two tobacco peers both yielding 3.2%. This shows that Philip Morris' share price could rise by 22% and still yield the same as Altria and Reynolds, which in our view indicates that there is clear upside potential.

Sure, interest rates are likely to rise over the medium to long term, but even in a more 'normal' interest rate environment, we would argue that a 3.9% yield from a stable, resilient and robust company such as Philip Morris is difficult to justify. Therefore, we think that a yield compression will take place as investor demand for such a high yield acts as a positive catalyst and pushes Philip Morris' share price higher.

The second positive catalyst which we feel will boost Philip Morris' share price is its exposure to international markets. In our view, this provides it with excellent growth potential since the absolute number of smokers is set to rise outside of the US moving forward.

Unlike in the US, the absolute number of smokers across the globe is rising, with it being estimated that smokers in low and middle income countries now account for around 80% of the world's smokers. In contrast, in the US the total number of cigarettes smoked each year is forecast to fall from 274 billion in 2013 to 122 billion in 2040. That's a fall of 3% per annum and with the world's population expected to rise from 7.2 billion to 9.7 billion between now and 2050, the prospect for tobacco companies in the emerging world remains relatively positive.

Sure, increased regulation and a more health conscious consumer are risks to the rise in demand for cigarettes in the emerging world. But with GDP per capita forecast to quadruple across the emerging world by 2060, smoking is likely to become increasingly affordable and this presents Philip Morris with greater pricing potential moving forward due to the relatively inelastic nature of demand for cigarettes. In our view, this mix of rising cigarette volumes and higher prices will cause rising profitability for Philip Morris which will positively catalyze investor sentiment and its share price.

The third positive catalyst which could push Philip Morris' share price higher is reduced risk products (RRPs). While many investors see e-cigarettes as an endpoint for RRPs in terms of them being the only rival to cigarettes moving forward, we see a landscape where new RRPs are continually being developed and released in future. And we believe that the tobacco companies which are able to successfully adapt their product range to faster changing consumer tastes in RRPs will win.

That's why we're upbeat about Philip Morris' collusion with Altria in the RRP space. Both companies have further expanded their agreement and with Philip Morris now leveraging the strength of the Marlboro brand via Marlboro Heatsticks to potentially cross sell RRP's to existing Marlboro customers, we think that the company's investment and marketing strategy in this space is strong. And moving forward, we believe that increased sales of RRPs will boost Philip Morris' profitability and act as a positive catalyst on its share price.

Of course, Philip Morris comes with risks. For starters, its international exposure can be a double-edged sword in terms of currency translation. While the US dollar has weakened somewhat this year and this has helped Philip Morris' earnings, it can go the other way as was the case in 2015 when it reduced EPS by $1.20 per share.

Further, the pricing potential of tobacco companies in general may not be as high as many investors realize. That's because the price elasticity of demand for cigarettes has been estimated to be-0.3 to -0.5 , which indicates that price increases will have a negative impact on volumes. However, we believe that the increasing incomes in the emerging world plus population rises will create significant pricing and volume increases moving forward.

With Philip Morris having a high yield, international exposure and a sound strategy regarding RRPs, we believe that it has three clear catalysts to push its share price higher moving forward. As such, we continue to be bullish about its future prospects.

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Disclosure: I/we 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.

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