Please Note: Blog posts are not selected, edited or screened by Seeking Alpha editors.

Philip Morris International: Money Machine

|Includes: Philip Morris International Inc. (PM)

Philip Morris International

I would suggest that every investor have a permanent position in this company, particularly offshore tax-efficient investors. Some might think it boring, there is no catalyst and many investors would prefer to find more challenging ideas but personally, I haven't found an easier way to make money.

Readers will be familiar with Philip Morris International so I will get right down to what makes this a special investment and investors who want more information should go to the PM website - or ask me to elaborate on particular points.

1. Free cash flow and free cash flow discipline.



$bn Revenues OPBDA Interest Tax Capex FCF Dividend Share Rep Cash Return Net Debt Shares Outstanding
2008 63.6 11.1 0.3 2.8 1.1 6.9 2.1 5.1 7.2 11.5 2.01
2009 62.1 10.9 0.8 2.7 0.7 6.7 4.3 5.4 9.7 13.9 1.89
2010 67.7 12.1 0.9 2.8 0.7 7.7 4.4 4.8 9.2 14.8 1.80
2011 76.3 14.3 0.8 3.7 0.9 8.9 4.8 5.3 10.1 16.0 1.73
2012 9mo 57.7 11.3 0.6 3.0 0.7 7.0 4.0 4.6 8.6 17.7 1.67

This business has trivial capex, growth comes from pricing not capital reinvestment. With leverage around 1.2 times OPDA ,net debt has room to grow. I like to think about it like this: capex and interest on debt of 1.5-2.0bn can be funded by issuing additional debt for a long time. So I think it reasonable to use OPDA(1-t) as a proxy for Shareholder's free cash flow, and I think that management's dividend and share repurchase history suggest that that is how they think about it too.


OBPDA (1-t)

Cash returned













2012 9mo






So I look at OPDA(1-t) as my FCF and all of it gets paid out to me every year as dividend and share repurchase. At the current market cap of 144bn the 2012 payouts of 5.5bn dividend and 6.0bn share repurchase equate to a 8% yield.

The company's management believes that they can get around 1% volume growth, 5% revenue growth and 7% OPDA growth. Other things being equal the company's intrinsic value should grow proportionately to OPDA, so 7%. Looking at FCF yield and IV growth together, and given that they do not need to retain the former to gain the latter, I think this gives me a fairly clear runway to circa 15% CAGR.

2. Rate of change of intrinsic value. I have spent many years making investments with a too static conception of intrinsic value, but it is difficult to exaggerate the importance of a rising intrinsic value. I've come to think that a 25% discount to an IV growing at 10% is usually better than a 40% discount where the IV goes nowhere and where as a passive minority shareholder one has no ability to catalyze a value recognizing event. I know this is probably a stupid point and most investors know this already but personally I have really under-appreciated this point all through my investing career. There are two additional benefits: no switching costs if one can stay put in a good thing and benefiting from accumulated intelligence from focusing on a single business over many years.

3. PM qualifies as an 80/20 company and as such there is no automatic withholding tax on its dividends. Offshore investors therefore receive the totality of the dividend payout. Offshore investors who invest through tax haven entities are used to losing 30% of their dividends. On PM's 4% yield that amounts to 1.2% of return that is lost every year. As anyone knows who's played around with compound interest numbers over long periods of time 1% differences end up having very large effects after decades. Taken together with management's tremendous track record of FCF discipline PM is one of very few companies where one can count on FCF arriving in one's pocket without getting molested by foolish capital allocation decisions and without the taxman taking a cut.

4. The world tobacco markets are dominated by four companies: PM, BAT, JT and Imperial. PM has the best brand, best management and the largest market share. Thanks to these three factors together with strict marketing restrictions PM has a tremendous economic moat.

4. Tobacco is an unpopular business with a constant stream of negative regulatory measures. One can write at length about these matters but I want to make two exceedingly simple points.

(i) Regulation unfolds slowly over time and PM is widely diversified across different countries and different regulatory bodies.

(ii) Use the lesson of US Regulation. Regulation, litigation (MSA, Engle etc) and smoking cessation (40% of the population to 20%) in the USA over the last few decades didn't stop tobacco companies increasing operating income annually at mid to high single digits.

5. Unknown upside: China and/or alternative nicotine delivery devices. Unknown downsides: nicotine vaccination and/or outright prohibition.

I'm happy to go into much greater detail on any of the above points should anyone be interested.