- To estimate the stock's fair value, we used dividend discount models and scenario analysis and compared our results to estimates based on traditional price multiples within the tobacco industry.
- While Philip Morris may have a growth potential ahead due to new opportunities in the smoke-free tobacco market, the risks related to potential regulations need to be kept in mind.
- For these reasons, we assign PM stock a neutral rating.
Philip Morris International Inc. (NYSE:PM) operates as a tobacco company working to deliver a smoke-free future and evolving portfolio for the long-term to include products outside of the tobacco and nicotine sector.
Today, we have decided to write about PM, as its stock has substantially outperformed the broader market in the past 12 months, despite the challenging macroeconomic environment.
The firm also pays a $1.27 quarterly dividend, which corresponds to a more than 5% annual yield. Also important to mention that PM has a strong track record of returning value to its shareholders in the form of dividend payments. They have been paying dividends in each of the last 14 years, and they have also managed to increase these payments each year.
On one hand, the company indeed has relatively high payout ratio, which may appear troubling at first sight, especially when we compare these figures with the respective sector medians.
On the other hand, the current payout ratios appear to be in line with the firm's own 5Y averages, which makes us believe that these payments are likely to remain sustainable at these levels.
As the dividend is playing a central role in our investment thesis, to determine whether the PM's stock could be a good investment for dividend- and dividend growth investors, we will be using various dividend discount models for estimating the stock's fair value.
Before we start our analysis, we have to make one assumption that will be used across all of our scenarios. The required rate of return for all of our cases will be the firm's weighted average cost of capital (WACC), which is estimated to be about 9.75%.
This will be our simplest approach. In this scenario, we will be using a single stage dividend discount model. Our assumption is that the firm's long-term average dividend growth rate of 4.3% remains sustainable in perpetuity.
Using the above defined assumptions our calculations yield the following results:
The fair value of the stock using this approach is estimated to be $102 per share, representing a 3% upside from the current price levels.
Now, one might argue that having a single stage dividend discount model is overly simplistic and that a 4.3% dividend growth rate in perpetuity is too high, which both are fair arguments. And this takes us to scenario 2.
In this scenario, in the first stage of the dividend growth we will be using a higher, but gradually declining growth rate over time. The growth rate estimates will be partially based on analyst estimates. In the second stage, we will be using a perpetual growth rate of 3%, which is closer to the overall growth rate of the economy.
Using this approach, we estimate the stock fair value to be $88 per share, representing a roughly 11% downside from the current price levels.
We believe that this scenario is more realistic than the first one. As you can see in the tables, the terminal values based on the perpetual dividend growth rate make up a substantial portion of the fair value. Having too high assumed growth rates in perpetuity can lead to significant overestimation of the fair value.
This conclusion is also supported by most of the traditional price multiples. Comparing PM's multiples, with those of its peers, it appears that the firm is trading at a premium compared to them.
One can, however, argue that the premium is justified due to the firm's growth in the smoke-free tobacco space. This topic has been recently analysed more in detail by another Seeking Alpha contributor in an article titled: Philip Morris: Next Generation Tobacco Play Through Smoke-Free IQOS. The firm has even been upgraded recently at J.P. Morgan, citing strong growth potential. The ones mentioned in these articles are indeed fair points, but we also cannot forget about potential risks. The recent legislation of banning the sale of cigarettes and tobacco products to people born after 01.01.2009 in New Zealand may be just the first of many such decisions.
For these reasons, we believe that at the current price level may not be the optimal entry point. We would like to see the stock price come down below $88, before we would rate the stock as a "buy". Over the past years, the stock has been trading below $88 quite a few times, so we believe it is not unlikely that we would see it reach this price territory once again in the near future.
This article was written by
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.
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