Philip Morris: The Russia Problem

Summary

• Shares decline after Russia invades Ukraine.
• Business impact will hurt a little this year.
• Find a yield point to target your purchase.

Spencer Platt/Getty Images News

In the past few days, shares of cigarette giant Philip Morris (NYSE:PM) have declined after Russia's invasion of Ukraine. The stock is now down more than 10% from its high as investors are curious as to how this military engagement may impact the company's results. Today, I'd like to discuss some of the key numbers here and determine where those who want to buy could look to enter.

Last week, it was announced that Philip Morris had suspended operations in Ukraine. The company had a facility in one of the areas that Russia was attacking, and it employed over 1,300 people. As the link above details, Ukraine accounted for around 2% of PMI’s total cigarette and heated tobacco unit shipment volume and under 2% of PMI’s total revenue. The facility will restart when things are safe, but nobody knows when that may be.

As the world grapples with supply chain issues already, this disruption is certainly not helpful. Ukraine was not a major sales country for Philip Morris, but Russia on the other hand is another story. As the graphic below shows, Russia accounted for 8.4% of cigarette shipments in 2021 and more than 17.1% of heated tobacco unit volume. This makes Russia the second most important individual country behind Indonesia.

Key Market Data (Q4 Report)

Being that the conflict only started last week, I don't think we'll get an update from management right away on the overall impact here. However, it's likely that you will see some sales pressure, perhaps impacting total revenues by a couple of percent. It doesn't help that the Russian Ruble has dropped more than 36% already against the US Dollar since the Q4 earnings report, which only adds to revenue headwinds. With economic pain likely to significantly impact the Russian economy moving forward, cigarette demand could easily be hit here.

We likely will get a major update from the company at the Q1 earnings report, which should be in mid to late April. Beyond the potential for revenue growth to be lowered, we're also looking at an increase in the negative earnings impact from currencies figure. This conflict, along with the possibility for the Federal Reserve to start raising rates at the March meeting has been good for the US Dollar, up nearly 2% against the Euro for instance, since the Q4 report. The only good news here is that management did not include any share repurchases in its yearly guidance, so the EPS hit will be softened a little if Philip Morris shares are bought back during the year.

For a company like Philip Morris, it's not just revenues and earnings that investors care about. Capital returns such as the buyback and dividend have made the name a favorite over the years. As we saw for most of the last decade, a stronger dollar has the ability to materially impact free cash flow, which was originally projected to be $10 billion this year. Even if only a few hundred million of that is lost in the end, that leaves less money for dividend payments, the buyback, debt repayments, etc.

So how can investors determine a good entry point for the stock? Well, if you are a long-term investor, you're probably in this name for the dividend, so the annual yield is a good place to start. Philip Morris has a $1.25 quarterly dividend currently, a rate that's been paid twice already. Later this year, we should get a raise from the company, and for now, my current assumption is that we'll match last year's increase of 5 cents to $1.30 per quarter. Free cash flow more than supports this raise, and the buyback helping the share count come down a little too can allow the dividend to rise without total cash payments increasing too much.

Thus, over the next 12 months, my projection is for a total dividend payment of $5.10. When I look at a name like this, I want a yield that will beat fixed income plus a level of inflation. Currently, the 10-year Treasury is 1.858%, and given that the Fed is letting inflation run hotter than its 2.0% target, let's put the longer-term inflation level at 2.5%. For some investors, there are also taxes on dividends to consider, so for simplicity, I'm going to add one percentage point of yield to cover that. Thus, my target yield on Philip Morris would be 5.358%, or about $95.18 per share. For those that like even dollar amounts, you could certainly decide to go with $95 if you prefer.

In the end, Philip Morris shares have been hit recently after Russia's invasion of Ukraine. The company has closed its factory in the war zone, but the larger impact may come from Russia being the company's second-largest sales country. It would not surprise me to see a guidance cut at the Q1 report, especially on the earnings side if the US dollar continues to strengthen. The good news is that the company's long-term prospects remain rather healthy, so for investors looking to enter the stock, I laid out a potential entry price where I think shares look attractive.

Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such 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.

Investors are always reminded that before making any investment, you should do your own proper due diligence on any name directly or indirectly mentioned in this article. Investors should also consider seeking advice from a broker or financial adviser before making any investment decisions. Any material in this article should be considered general information, and not relied on as a formal investment recommendation.