Philip Morris: Lock In A Solid Yield While The Market Is Confused

Summary

• PM has a leading position in the smoke-free space, bolstered by strong growth from its IQOS heat-not-burn product.
• It's seeing strong traction and further ILUMA launches across markets could accelerate growth.
• Meanwhile, it pays an attractive dividend yield and is reasonably attractive at present for potential long-term income and growth.
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MarsBars

It's tempting to layer into very high yielding stocks right now, such as mortgage REITs, many of which now offer double-digit yields. However, those who prefer to sleep well at night may want to consider dividends that they can count on. Such I find the case to be with Philip Morris International (NYSE:PM), which I last covered here back in November of last year, highlighting its big opportunities ahead.

The stock actually declined by 2% since my last piece, but the total return has been flat thanks to dividends along the way. Believe it or not, a stagnating stock price on a quality stock is actually a good thing for income investors, as that gives the opportunity to accumulate more shares and grow one's dividend stream. In this article, I highlight PM's recent results and discuss why it's a great time to add this premium income stock.

Why PM?

Philip Morris often gets mentioned in the same breath with its former parent Altria (MO) and peer British American Tobacco (BTI). However, it's fundamentally different in that it's considered to be the highest quality company in the tobacco space.

That's because it's had the foresight to take an early and enduring lead in heated tobacco space with IQOS. The popularity of IQOS has greatly helped PM to stem the decline of traditional combustibles. This is reflected by PM's recent first quarter results, which showed that cigarette and heated tobacco unit shipment volume declined by just 1.1% YoY.

For reference, cigarette volume declined by 3.1% YoY while heated tobacco volume grew 10.4% YoY. This, combined with price increases and strong showings with ZYN nicotine pouches helped PM to grow net revenue excluding currency effects by an impressive 9.6% YoY.

Meanwhile, ZYN continues to see strong traction as the leader in the nicotine pouch category, with shipment volume growing by an outstanding 47% YoY to 73 million cans during Q1. IQOS users also grew by a robust 0.9 million on a sequential quarter on quarter basis to 25.8 million users. Impressively, PM now gets 35% of its revenues from smoke-free products.

As shown below, IQOS users grew by 14% since the prior year period, and the product is undoubtedly capturing share from traditional cigarettes, as 72% of IQOS users have stopped smoking.

Investor Presentation

Headwinds to PM include to business disruptions in Russia and Ukraine, and from potential from increased competition from British American Tobacco. Moreover, Altria recently signed an agreement with Japan Tobacco (OTCPK:JAPAF) to explore commercial opportunities for heated tobacco pods internationally. Nonetheless, PM's new ILUMA device holds plenty of promise. This device heats by induction rather than using a heating blade.

This makes it unnecessary for the user to have to clean the device and importantly, means that the product is outside the purview of British American Tobacco's patents around heated blade technology. PM has already launched ILUMA in Japan, where it's seen an acceleration of market share growth. Management highlighted the potential forward benefits of this device during the recent earnings call:

For existing IQOS users, ILUMA drives an accelerated upgrade cycle. This enhances retention and full conversion for the future, with a temporary margin impact from concentrated device sales. Indeed, we are now approaching an estimated 10 million ILUMA users with ILUMA taking over 85% of HTU volumes in the first launch markets of Japan, Switzerland, and Spain.

ILUMA is also enabling better acquisition and conversion of legal-age smokers, with market share acceleration visible in both earlier and more recently launched markets such as Italy and Korea. Since the introduction in these two markets in Q4, we are seeing encouraging trends in initial launch areas and expect this to be increasingly visible at the national level over time as it is in Japan and Greece, after a seasonal inflection in the latter.

Meanwhile, PM carries a high investment grade credit rating of A- from S&P, which sits higher than that of its peers Altria and BAT. While its net debt to EBITDA is somewhat elevated at 2.9x as of the end of last year, Management expects leverage to improve by 0.2x after a full year's contribution from its Swedish Match acquisition.

Turning to the dividend, PM currently yields a respectable 5.3% and the dividend is covered by an 82% payout ratio based on expected adjusted EPS of $6.16 at the midpoint of guidance for the full year. Unlike peer BAT, PM is a U.S. company whose dividend is paid in U.S. dollars, so it's not subject to currency fluctuations.

Lastly, I find PM to be reasonably attractive at the current price of $95.10 with a forward PE of 15.2. This is considering the quality of the products and potential for meaningful revenue expansion in the U.S. through ZYN and the relaunch of IQOS in a few years, as this represents a net new market for PM. Analysts have a consensus Buy rating with an average price target of $113, which equates to a potential 24% total return over the next 12 months.

Investor Takeaway

Philip Morris International has a leading position in the smoke-free space, with strong growth from its IQOS heat not burn product. The company is also well positioned to benefit from the launch of its new ILUMA device which will drive an accelerated upgrade cycle for existing users and potentially better acquisition and conversion of smokers, especially in the U.S., which is a net new market for PM. Meanwhile, it currently provides a meaningful yield and is reasonably attractive at the current price for potentially strong long-term income and growth.

Analyst’s Disclosure: I/we have a beneficial long position in the shares of PM either through stock ownership, options, or other derivatives. 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.

I am not an investment advisor. This article is for informational purposes and does not constitute as financial advice. Readers are encouraged and expected to perform due diligence and draw their own conclusions prior to making any investment decisions.

Comments

[Always Bullish]

Totally agree with your analysis. Long PM and it’s on sale with a solid safe and rising dividend. Great addition for long-term investors seeking safe dividends that will lead them to early retirement

[bk25]

Good summary

[Bobbie B]

How about UVV? VGR?

[secorewb]

Your article proves PM is a lower risk stock than the rest of the tobacco stocks, the dividend rate is proof.
You can one or the other but not both.

[purpleboarder]

@secorewb Well, if the market is irrational, you can have both.... BTI is at the mercy of exchange rates, and MO is diversified in InBev (and at the whims of the market for that investment). Many moving parts for all tobacco companies, litigation, market sentiment, macro events not created by tobacco companies. It is possible to have both...

- Long PM, BTI

[secorewb]

@purpleboarder I was thinking of a single stock, I own both MO and PM, MO riskier hence bought for dividend. Agree with you on multiple stocks.
If you are investor buying a tobacco stock to diversify, I would suggest PM.

[racerkeith]

Good Article, $PM is a solid investment, even though I hold both, I prefer $BTI. The lower cost/share, dividend is 60% higher, 25%+ growth potential from current value and the stock is at the bottom of the 52-week range.

[ChuckXX]

@racerkeith Since you own BTI, tell me something. On their website they list the dividends in British money (yes, I know they are England based) but my question is when you go thru the foreign currency exchange rates what do you actually end up with as a dividend in American Money. I love the yield from BTI and it appears that they have never cut it so Iam taking a serious look at it since I'm an older investor.

[racerkeith]

@ChuckXX I'm 65 and am buying back in at the current prices.
From the BAT website: "For holders of ADSs listed on the New York Stock Exchange (NYSE), the equivalent quarterly dividends receivable by holders of ADSs in US dollars will be calculated based on the exchange rate on the applicable payment date. A fee of US$0.005 per ADS will be charged by Citibank, N.A. in its capacity as depositary bank for the British American Tobacco American Depositary Receipt (“ADR”) programme in respect of each quarterly dividend payment."

[purpleboarder]

@ChuckXX Your dividend payment is at the mercy of the exchange rates that day. So dividend payments will look 'lumpy'...