Today's Buy Opportunity: Philip Morris International

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Today, my "11 O'Clock Stock" is sin purveyor Philip Morris International (NYSE: PM  ) , the sister company of my previous 11 O'Clock Stock, Altria (NYSE: MO  ) . They share the dominant Marlboro cigarette brand -- and the ire of many investors.

Before we get to the reasons for that dislike, let's take a quick overview of the company.

Fast facts on Philip Morris International

Market Capitalization

$94.4 billion

Industry

Tobacco

Revenue (TTM)

$26.9 billion

Earnings (TTM)

$7.0 billion

Dividend Yield

4.5%

Source: Capital IQ, a division of Standard & Poor's. TTM is trailing 12 months.

As I did with my previous pick, I'm going to do something a little unorthodox today. I'm going to give you 10 reasons NOT to buy Philip Morris, in no particular order. Then I'll tell you why I still made Philip Morris today's "11 O'Clock Stock" pick.

You shouldn't buy Philip Morris International because ...

  1. You may have moral qualms because it's a tobacco company.
  2. It generates almost half of its sales in the European Union. Further economic weakness there could lead to folks downgrading to cheaper brands, or finally sticking to their New Year's resolutions and quitting altogether.
  3. Speaking of the European Union, most of the markets there are mature with respect to the tobacco industry. Hence, future growth prospects on a volume basis are dim.
  4. It's highly leveraged, with a debt/equity ratio of 3.7:1.
  5. The Chinese market, which contains 30% of the world's smokers, is a virtual monopoly of China National Tobacco. Philip Morris sells cigarettes under license in China, but its growth prospects there are limited unless the government opens up the market to true competition.
  6. Since Philip Morris is an American company that generates all of its sales in foreign currencies, its earnings can fluctuate significantly based on the strength of the dollar. (A weak dollar juices earnings, while a strong dollar hurts earnings.)
  7. The company's litigation risk will likely never go away. If anything, it could rise as markets mature.
  8. As it seeks to expand or strengthen its presence in markets around the world, it faces an array of country-specific risks and challenges.
  9. Excise taxes are hefty, and a good way for governments to make money easily. Expect them to continue rising.
  10. Smoking bans and other forms of regulation are ever-increasing.

We should take a closer look at Philip Morris' aggressive debt position. Let's compare it against a few companies in the utility industry, which is known for huge debt loads that are justified by steady earnings and cash flows.

Company

Debt/Equity

Payout Ratio

Interest Coverage

Dividend Yield

Philip Morris

375%

62%

       10.9

4.5%

FirstEnergy (NYSE: FE  )

169%

75%

       2.2

6.0%

Progress Energy (NYSE: PGN  )

129%

91%

       2.6

5.7%

PPL (NYSE: PPL  )

116%

103%

       2.5

5.1%

Consolidated Edison

106%

65%

       3.2

5.0%

Duke Energy

84%

186%

       3.7

5.6%

Source: Capital IQ, a division of Standard & Poor's.

Yes, Philip Morris has a significantly higher debt load and a smaller (though still quite tasty) dividend yield than the utilities, but its payout ratio is lower, and its interest coverage (via earnings before interest and taxes) is through the roof. Additionally, like the utilities, its business is relatively steady in good times and bad.

Now, on to the good stuff
I've given you 10 things to hate about Philip Morris International, but now I'm going to give you 11 things to love about it:

  1. It's the dominant cigarette company worldwide outside of China (where China National Tobacco has its aforementioned virtual monopoly).
  2. Even so, Philip Morris has only a 16% non-U.S. market share, and it plans on pushing growth in attractive countries like India.
  3. Did I mention its 4.5% dividend yield, with healthy interest coverage?
  4. The Marlboro brand is iconic worldwide.
  5. But Marlboro isn't alone in Philip Morris' brand portfolio. It boasts seven of the top 15 international cigarette brands.
  6. Tobacco has the benefit of inelastic demand, giving the industry considerable pricing power.
  7. Industry aside, Philip Morris also can rely on the pricing power of its premium brands.
  8. Philip Morris International provides U.S. investors with the rare opportunity to buy an American company that generates 100% of its sales in foreign countries. For a few comparison points, Pfizer (NYSE: PFE  ) generates 43% of its sales outside the U.S. and Ford (NYSE: F  ) is at about half its sales outside North America. It may surprise you that Procter & Gamble generates 62% of its sales outside the U.S., but that's still 38% short of an international pure play with U.S. corporate governance standards.
  9. The risks with Philip Morris International are generally out in the open (I listed them above). When risks are transparent, the market can factor them in, providing a discount for those risks.
  10. Over the past 12 months, its free cash flows were a good bit higher than its net income -- a very good thing.
  11. Philip Morris' margins are borderline ridiculous -- 41% operating margins and 26% net margins!

The bottom line
As part of a balanced portfolio, I believe the rewards outweigh the risks on Philip Morris International. Its brand power, growth opportunities, healthy dividend, and eye-popping margins combine to make it a company to strongly consider.

For folks looking to add a new position, Philip Morris International is reasonably priced today (around $51 a share), attractive below $45 a share, and a truck-backer-upper below $40 a share.

Previous recommendations:

Come back to Fool.com tomorrow for another great stock pick. There's plenty more great stock advice, and you can find video of each day's recommendation as well! To see the performance of previous recommendations, click here.

The Motley Fool will wait at least 24 hours after this publication before buying shares of Philip Morris International. To see an FAQ on "11 O'Clock Stock," click here.

Anand Chokkavelu owns shares of Philip Morris International, Altria, and Pfizer. Pfizer is a Motley Fool Inside Value pick. Ford Motor is a Motley Fool Stock Advisor recommendation. Philip Morris International is a Motley Fool Global Gains pick. Duke Energy is a Motley Fool Income Investor recommendation. The Fool owns shares of Altria. The Fool has a disclosure policy.


Read/Post Comments (10) | Recommend This Article (29)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On August 31, 2010, at 11:08 AM, rwwww wrote:

    By "sister" company (Altria) you mean what?

    PM was spun off, that means independent with no familial ties, on March 28, 2008.

  • Report this Comment On August 31, 2010, at 11:26 AM, mdk0611 wrote:

    Is there a potential tax trap for PM lurking in Congress? I'm referring specifically to making earnings of foreign subsidiaries taxable in the US at US corporate rates in the year they are earned as opposed to the year these earnings are repatriated. I'm not familiar enough with the corporate structure of PM to be sure, but it should be considered.

  • Report this Comment On August 31, 2010, at 11:49 AM, sagitarius84 wrote:

    Philip Morris International versus Altria:

    http://www.dividendgrowthinvestor.com/2009/07/philip-morris-...

  • Report this Comment On August 31, 2010, at 12:09 PM, czelbst wrote:

    I am constantly surprised to see Fool recommendations, and investments, in tobacco companies, not just because tobacco companies provide no positive product to their customers, and who requires a constant, never ending need to addict new customers, who will suffer the most horrible health issues as a direct result of using the product, but also because of the huge potential litigation facing these companies in India, the sub-Sahara, Asia (including China) and most of all the European Union. I cannot but wonder at times if there is some type of financial arrangement between Fool recommendations and these companies, as even the novice investor can find better dividend returns and pricing stability as well as opportunity for pricing growth without the adverse aspects inherent to investing with tobacco companies. If the return on investment is paramount then why put your money into something that is akin to a time bomb?

  • Report this Comment On August 31, 2010, at 1:08 PM, TMFBomb wrote:

    @rwwww,

    It's a fair distinction to make...I was using the term "sister company" loosely...as PM spun out of Altria and they share the Marlboro brand.

    -Anand

  • Report this Comment On August 31, 2010, at 1:54 PM, plange01 wrote:

    pm and its counter part mo are great stocks to own and have large dividends.pm under $50 and mo $18..nice buys...

  • Report this Comment On August 31, 2010, at 3:11 PM, shivy1 wrote:

    Anand,

    Good pick, I remember you picked MO before. I like PM because of the international exposure. China and India have high amount of smokers and are increasing more and more.

    - Tony

  • Report this Comment On August 31, 2010, at 4:22 PM, ingarf wrote:

    You can argue if it is morally correct to invest in a company that creates addictive products that lead to early death, but one thing is for sure. SMOKING IS NOT THE TREND! Fewer people smoke now than earlier. It is just plain wrong to invest long term money into smoke companies. Ever read about Rule Breakers? MO and PM are "try to keep the old rules" companies.

  • Report this Comment On September 01, 2010, at 1:32 PM, mikecart1 wrote:

    MO is still better IMO. Better dividend. Longer history. Better products. You can't say NO to MO!

  • Report this Comment On September 03, 2010, at 11:51 AM, ruddysantos wrote:

    I have checked the numbers of profit margins and they are wrong, net margin is 10% and operarting profit is 16%, (using financials as of Dec 31,2009 in PMI annual report), everything else seems fine,

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