Last week, the European Central Bank (ECB) slashed its 2019 growth forecast, talking about political uncertainties as well as emerging market weakness. As a result, the US dollar saw a nice little bid, most of which held through the weekend despite a big U.S. jobs report miss on Friday. Unfortunately, a stronger dollar is not what shareholders of Philip Morris (PM) want to see. If I sound like a broken record, it is because currencies have been a major headwind for the company for a number of years.
Of course, before I discuss the dollar's movement, let's not forget that weaker economies themselves can be a big risk for the firm. Last year, the European Union and Eastern Europe represented more than $13 billion of the company's nearly $30 billion in net revenue. Most of that came from the traditional cigarette business, but these regions are where PM is currently looking for massive growth in its reduced risk products as well.
Looking back at 2018, management originally forecast a 16 cent earnings per share benefit from currency movements. Unfortunately, at that time, it wasn't enough to even cover the previous year's FX hit, let alone the five years before that that were many times worse. Throughout 2018, the US dollar slowly strengthened and in the end, the company reported an 11 cent EPS hit for yearly earnings per share due to currencies.
Since the U.S. dollar was much weaker a year ago than it is currently, the company is still facing a currency headwind when comparing the two periods. At the Q4 report back in early February, management called for a 14 cent hit this year due to currencies. Unfortunately, as you can see in the table below, the dollar has strengthened a bit versus almost all major currencies that impact the company since then.
(Source: cnbc.com currency page, seen here)
If you were to assume a 1% across-the-board hit, that would equal a little more than 5 cents of earnings per share based on current expectations. While that's not a tremendous amount overall, it's still a roughly $80 million hit to net income, and that likely will hurt cash flow as well. The situation could easily get much worse with further dollar strengthening. Back in 2015, the EPS hit from currencies was about $1.20 per share, which is massive.
Remember, part of the current bull case for Philip Morris is that it will generate about $8.9 billion of free cash flow this year. With dividends being around $7.2 billion as I project, that would mean $1.7 billion that could be used for either acquisitions, a restart of share repurchases (management has guided to zero share repurchases currently), or perhaps to reduce the company's large debt load. Take a few hundred million off because of currencies, and buyback plans would be completely off the table, and debt repayments would have to come down a little, further impacting the earnings scenario moving forward.
As you can see in the chart below, shares of the company have risen more than 12% in the past month. Most of the rally came in the first couple weeks after earnings, as that report was fairly decent as I mentioned in the article linked above. However, with the dollar strengthening a little lately, it looks like the rally has stalled out a little in the high $80s. Shares closed Monday just a tick above the average street price target of $89.12, so it would seem that the stock is fairly valued currently according to analysts.
(Source: Seeking Alpha PM page, seen here)
In the end, a minor worry has popped up for Philip Morris, and unfortunately, it's the one that has bugged investors for most of this decade. The US dollar is strengthening again, mostly thanks to a growth cut forecast by the ECB and the decision to have a more accommodative monetary policy. Should we not see a decent pullback in the USD before the company's April earnings report, we will definitely see a negative update on the forecast because of currencies. As a result, I'd be slightly cautious with shares of the cigarette giant in the near term. With shares up 38% from their 52-week low, a small pullback could be in the cards.
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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