Philip Morris International PM
Analyst Note 02-07-2013 | Thomas Mullarkey, CFA
Philip Morris International’s PM full-year 2012 results show that the company remains a wide-moat juggernaut. The firm, which distributes tobacco products in more than 180 countries, grew its global cigarette shipments by 1.3% despite continued weakness in Europe (where it derives 30% of the firm’s operating profits). We continue to believe that the company’s addictive brands will benefit investors over the long term thanks to their strong pricing power and diversified global supply chain. During 2012, PMI’s adjusted earnings per share were $5.22, up 7% versus the $4.88 earned in 2011. Looking ahead to 2013, the company expects to earn $5.68 to $5.78 per share (which includes $0.06 of unfavorable foreign currency impact) roughly in line with our prior estimate of $5.82 (which wasn’t adjusted for currency) Given that the firm anticipates buying back another $6 billion of stock (4% of outstanding shares) during 2013, we believe that the Philip Morris will likely attain the high end of its guidance. As we incorporate the company’s strong performance, solid guidance, robust stock repurchase plans, and the time-value of money, we are increasing our fair value estimate to $95 from $92. Our new fair value estimate values the company at a 2013 P/E of 16.5 times and an EV/EBITDA of 11 times.
During 2012, the company’s EU business segment saw shrinking volumes, revenue contraction, and margin erosion. Industrywide cigarette volumes in the EU fell 6.3% to 520 billion during 2012, and PMI’s volumes for the region fell somewhat faster (down 6.4%). Relative strength in Finland, Germany, and Poland were more than offset by declines in Southern Europe. For example, the economic malaise in Italy and Spain resulted in cigarette volumes falling 7.9% and 11.7%, respectively, during 2012. Excluding excise taxes, segment revenues fell 7.4% to $8.5 billion, and segment operating profit dropped to $4.2 billion (49.1% of sales) from $4.6 billion (49.5% of sales) in the year ago period. Despite this lackluster performance, the Marlboro brand managed to gain share during 2012. However, we expect 2013 will be more of the same, and anticipate that the EU segment’s operating profit will be slightly lower than what it generated in 2012.
Asia continues to be a growth engine for Philip Morris. During 2012, the company’s cigarette volumes in the region climbed 4.2% driven by outperformance in Indonesia, the Philippines, Thailand, and Vietnam. Excluding the incremental 6.3 billion cigarettes PMI sold in Japan following the 2011 earthquake/tsunami, cigarette volumes in Asia increased 6.4%. The Indonesian cigarette market climbed 8.2% surpassing 300 billion sticks, or roughly 1,250 cigarettes per person. PMI gained 280 bps of share during the year, garnering 35.6% of the Indonesian market. Offsetting this growth were volume declines in both Japan (-0.7%) and South Korea (-0.9%). Segment operating profit for the year increased to $5.2 billion (46.4% of sales) versus $4.8 billion (45.2% of sales) in 2011. We continue to believe that over the next five years, Asia will be the key driver of PMI’s volume growth and profit growth.
Given Philip Morris International’s geographic breadth, it is inevitable that in any given year various groups will attempt to increase regulations or excise taxes against tobacco companies—this is nothing new. Recent items of note include: (1) Plain packaging in Australia (December 2012), which PMI notes has not had a meaningful impact on industry volumes or market share splits and (2) Increased excise taxes in the Philippines. A premium pack of Marlboros now has PHP 25 of excise taxes versus PHP 12, and the value-brand Fortune is now taxed at PHP 12 versus PHP 2.72. Consequently, PMI has raised the suggested retail price-per-pack of Marlboro and Fortune by 59% (+PHP 19) and 70% (+PHP 10.5), respectively. These higher prices will likely result in volume declines of 20% to 25% in the Philippines. (3) Further, the EU’s new Tobacco Products Directive (TPD) seeks to ban menthol and slim cigarettes, which represent 10% of European volumes. However, the TPD must still be approved by the European Council of Ministers and the European Parliament. We expect these negotiations to take some time, and wouldn’t be surprised if less punitive measures get adopted sometime in 2015 or 2016.
Philip Morris International: Investment Thesis 02-07-2013
Philip Morris International’s premium positioning of its strong brands, global scale, and addictive products give the firm a wide economic moat, in our opinion. While some of the company’s more mature markets are experiencing lower cigarette demand, we expect that the company’s Asian operations will continue to be an engine for the firm’s future growth.
We think that Philip Morris has some sustainable competitive advantages. It owns seven of the leading 15 international cigarette brands, including: Marlboro, Parliament, Chesterfield, and Bond Street. The firm is the dominant player in the European Union and holds leading positions in much of Eastern Europe, the Middle East and Africa, and Asia. The firm is well balanced between developed and emerging countries. Philip Morris’ strong market share positions, which give the firm economies of scale, and premium positioning of products have been the primary drivers behind the company’s industry-leading operating margins, which have been consistently above 40%.
Philip Morris’ exposure to emerging markets is a key differentiator for the firm versus other tobacco companies, such as Altria MO, Reynolds American RAI, and Lorillard LO, that are focused on the U.S. market. Many overseas markets in Asia, Africa, and Eastern Europe have growing populations and looser restrictions on tobacco marketing. This, combined with rising incomes, should result in growing unit volumes for Philip Morris International over the next decade. The firm has identified several Asian countries such as India, Bangladesh, and Vietnam as potentially lucrative growth markets. Although the Chinese cigarette market is predominantly a monopoly, Philip Morris has entered into a joint venture with China National Tobacco to cross-sell products. The JV, which licenses the Marlboro brand in China and promotes Chinese heritage brands in international markets, is currently not a significant part of Philip Morris’ business. And we don’t anticipate that the Chinese government will open up their cigarette market to full-blown competition anytime soon.
Although Philip Morris has attractive long-term potential, some challenges may provide headwinds to the company’s robust profitability. Consumption levels in many developed countries are on the wane, and during times of economic uncertainty some consumers quit and others switch to cheaper brands. Additionally, the firm consistently faces threats of increased regulation, taxation, and litigation. In 2012, for every $1 of revenue Philip Morris took in it collected $1.47 in excise taxes. Cash-strapped governments have consistently increased tax rates on tobacco. Given that Philip Morris competes in 180 countries, we expect that each year there will be many countries that ratchet up their excise tax rate.
We believe that the high tax burden on cigarettes, combined with the addictive qualities of nicotine and the strength of Philip Morris’ brands give the company tremendous pricing power. Over the last five years, the company’s average revenue per cigarette, excluding excise taxes, has grown an average of 6% per year. This pricing power, combined with operational efficiencies, and increased financial leverage have helped the company to steadily pay out an increasing dividend and to be a large purchaser of its shares. Over the next three years, we believe the company has the ability to pay out more than $17 billion in total dividends and to buy back more than $10 billion worth of its stock. We believe that these qualities make Philip Morris one of the best-positioned tobacco firms for long-term investors.
Philip Morris International: Valuation
Following the company’s fourth-quarter earnings, we have increased our fair value estimate to $95 from $92 as a result of the firm’s strong performance, solid guidance, robust stock repurchase plans, and the time value of money. Our valuation implies 2013 price/earnings of 16.5 times, an EV/EBITDA of 11 times, and a dividend yield of 3.6%. For 2013, we expect the company to grow revenue by 5.7% to $33.2 billion and to generate 43.9% operating margins. Longer term, we expect the company to increase revenue by 6% per year. Additionally we believe the company’s long-term operating margin should approach 44%, matching what it delivered in 2012. We believe the company’s margins in emerging markets should steadily climb as volumes grow and consumers shift to more premium brands. We estimate that after 2014 the company’s revenue from the EU will grow at a modest 1.5% rate over the next decade as pricing gains more than offset volume declines. However, we expect the company to grow long-term revenue by 5% to 6% in Eastern Europe, Middle East & Africa; 9% to 10% in Asia, and about 5% in its Latin America and Canada segment.
Philip Morris International: Risk
Although Philip Morris has never lost a major tobacco-related lawsuit, there is no shortage of lawyers looking to get a large judgment or settlement out of the company. While we view this to be a low-probability event, tobacco investors should have the fortitude to handle some “fat tail” risk. Additionally, legislation may have negative impacts on the company. If many governments drastically increase their tobacco excise tax rates, the company’s production volumes and profitability could suffer. And some governments are considering plain packaging for cigarettes. Although, we view it unlikely that courts would permit a company’s brand imagery to be usurped, should such legislation take effect consumers may be more likely to purchase low-priced cigarettes. Additionally, in 2012 European regulators passed a “Tobacco Products Directive” which seeks to ban menthol- and slim-cigarettes. This directive will likely not go into effect until 2015 or 2016, and could be changed while the European Parliament goes about voting on the issue. Finally, the company generates revenue in a wide range of foreign currencies and reports in U.S. dollars; a strong dollar can adversely affect the firm’s performance, and make it more costly for the company to repatriate cash in which to pay dividends and buy back shares.
The Board of Directors of Philip Morris International Inc. (NYSE Euronext Paris: PM) today increased the company’s regular quarterly dividend by 10.4%, to an annualized rate of $3.40 per share.
The new quarterly dividend of $0.85 per share, up from $0.77 per share, is payable on October 11, 2012, to stockholders of record as of September 27, 2012. The ex-dividend date is September 25, 2012.
Philip Morris International Inc.
Philip Morris International Inc. (PMI) is the leading international tobacco company, with seven of the world’s top 15 international brands, including Marlboro, the number one cigarette brand worldwide. PMI’s products are sold in approximately 180 countries. In 2011, the company held an estimated 16.0% share of the total international cigarette market outside of the U.S., or 28.1% excluding the People’s Republic of China and the U.S. For more information, see www.pmi.com.
Philip Morris Sparks Interest
A just announced $18 billion stock buyback and 3.7% dividend yield should light up the tobacco giant’s stock.
It’s no exaggeration to describe Philip Morris’ cash flow as smokin’, but what’s even hotter is the cigarette maker’s plan to repurchase $18 billion in stock.
While it’s a staggering figure, representing more than 10% of the company’s market capitalization, Philip Morris International (ticker: PM) has returned to shareholders about $40 billion in total through dividends and share repurchases since March 2008 when it separated its U.S. business with the spinout of Altria Group (MO). The new buyback will be accomplished over three years starting Aug. 1; Philip Morris is just completing a three-year $12 billion buyback.
Shares of Philip Morris rose $1.70, or 2%, to $86.73 on an otherwise flat day for the Dow.
Today, the bullish scenario for the stock requires that cigarette sales take off in emerging markets and that could bring a stock price near $105, according to Morgan Stanley’s best-case of three scenarios for Philip Morris. Analyst David Adelman’s price target, however, is $90, based on a middle-of-the road analysis for the stock.
While that’s only upside of 4%, the rich 3.7% dividend yield and the possibility that it could rise make for an enticing investment for conservative investors facing down stubbornly low interest rates.
Analysts expect Philip Morris to produce long-term earnings growth of 10%, with earnings per share of $5.25 in 2012, and $5.81 in 2013. The stock is trading at 16.5 times this year’s earnings, and about 15 times next year’s estimate. That’s a significant premium to the 12.4 multiple of the Standard & Poor’s 500 index, but it may be deserved for the strength of the brand, cash on the balance sheet and attractive yield.
Adelman cautions that rising excise taxes and competition are risks for the stock.
But Philip Morris also is likely to look forward to improving market share and pricing in Japan, and opportunities in China; Adelman has an Overweight rating on the stock.
CEO Louis Camilleri called the buyback announcement a testament to “steadfast commitment to generously reward our shareholders over the long-term.”
Camilleri was selling shares of Philip Morris at an average price of $85.63 in May, shortly after shares reached an all-time high near $91. But Philip Morris told Barrons.com at the time that while Camilleri sold 70,000 shares then, he still had a beneficial ownership stake of 1.6 million shares. (See Inside Scoop, “Philip Morris CEO’s $6 Million Sale,” May 14.)
And those shares have been good to him and shareholders.
Philip Morris stock has produced a total return of 100% since March 31, 2008, through the end of May, with 33 points of that return coming from the yield. In the same period, Altria generated a total return of 88% including 43 percentage points from the dividend. Meanwhile the S&P 500 eked out an 8.7% total return thanks exclusively to payouts.
Shares have nearly doubled since we suggested in June 2010 that investors shouldn’t quit the stock. (See Weekday Trader, “Get Fired Up Over Philip Morris,” June 3, 2010.)
Philip Morris may raise its payout in the third quarter, according to the dividend forecasting arm of Markit, a financial information services company. After all, buybacks are increasing: They have amounted to something between $5 billion and $5.5 billion per year in recent years, and the new buyback averages $6 billion per year.
Meanwhile, Philip Morris’ payout ratio – at 60% — and its forward-looking yield of 3.9% are lower than its peers.
Altria, Reynolds American (RAI) and Lorillard (LO) boast an average payout ratio of 76% (Lorillard is lowest at 71%), according to estimates for 2012 by Markit. Altria’s indicated yield is 6.6%, while Lorillard’s is 5.3% and that of Reynolds American is 5.9%, according to Markit estimates.
Markit says it expects Reynolds could raise its payout in the fourth quarter. It sees Philip Morris doing so in the third quarter.
There should be more color on cash flow, buybacks and dividends from the company’s investor meeting next week and earnings report in July.