Philip Morris Stock Is Going Nowhere. Here's Why.

The commonly accepted wisdom in the cigarette industry goes something like this: Smoking is in decline in the United States. Therefore, if you want to make money on tobacco, you must look abroad. You must buy Philip Morris International (NYSE: PM  ) stock.

The problem, though, is that this commonly accepted wisdom is dead wrong. Tobacco investors can do quite well by buying a domestic cigarette business. In contrast, Philip Morris stock is looking overpriced today, and unlikely to outperform going forward. Why?

Three reasons.

Philip Morris stock is at the bottom of the pack
When you stack up Philip Morris stock against its rivals, it quickly becomes apparent that investors have been overpaying for an inferior company. Valued on its earnings, a share of Philip Morris stock will cost you 18.1 times earnings today, while a share of former parent Altria (NYSE: MO  ) costs only 17.2 times earnings, and a pack of Lorillard (NYSE: LO  ) shares sells for a P/E of just 14.1 -- 22% cheaper than Philip Morris.

Worse, when you lay the three companies side by side, you can plainly see that Philip Morris generates far less real cash profit than does the less popular Lorillard. As a matter of fact, its free cash flow yield is even a skosh smaller than that of Altria itself!

PM Free Cash Flow Yield Chart

PM free cash flow yield data by YCharts

Philip Morris isn't growing as fast as you've heard
Focused on the international market, Philip Morris stock is currently expected to grow faster than most of its peers. To this extent, what you've heard about the stock is probably true. What's interesting, though, is that Philip Morris isn't growing all that much faster than its rivals -- not enough to justify its costing 28% more than Lorillard, at least:

 

Second verse, same as the first
Of course, there's still the old investing truism to consider -- that investing isn't about what a stock has done in the past, but what it might do in the future.

Problem is, the advantage in growth rates that Philip Morris stock currently enjoys over its competitors is actually shrinking. From 226 basis points in "extra growth" versus Lorillard in the past five years, for example, it's expected to contract to an advantage of only 158 b.p. in the next five years:

Now, is this continued advantage in growth rates still big enough to justify paying four P/E points more for Philip Morris stock than a share of Lorillard costs? Maybe not, once you consider one final fact: What Philip Morris stock owners gain in added earnings growth, they give up in reduced dividend yield.

That's because faster-growing Philip Morris is actually a stingier dividend payer than either of its rivals. Lorillard shareholders, for example, receive a whopping 5% dividend yield on their shares, while Altria shareholders collect a nearly as good 4.8% yield. Philip Morris stock, in contrast, pays a relatively meager 3.6%.

Foolish takeaway
With a too-high stock price, a too-low dividend yield, and an earnings growth advantage that's shrinking, Philip Morris stock is priced to go nowhere.

Tobacco companies have been under siege in the U.S. for decades, as waves of litigation, regulation, and anti-smoking campaigns have given the industry a black eye. Yet Philip Morris International focuses on overseas markets, where business prospects generally look brighter. Investors have been happy with its stock's performance, but is Philip Morris still a buy? Find out in The Motley Fool's premium research report on the company, which includes in-depth analysis of its opportunities and challenges ahead. To claim your report, just click here now.


Read/Post Comments (5) | Recommend This Article (7)

Comments from our Foolish Readers

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  • Report this Comment On May 26, 2013, at 10:13 AM, EquityBull wrote:

    You are using comps to arrive at valuation. What you are not considering is risk. Regulation in USA much riskier than abroad. For example 85% of lorillard sales are Newport menthol and the FDA is now looking to ban that in cigarettes. If so this would devastate lorillard and Altria as well so risk is priced in. Your valuation must take into account all known info and risks

    Best bet is buying basket of pm, mo and LO

  • Report this Comment On May 26, 2013, at 11:05 AM, TMFDitty wrote:

    Not a bad point.

    On the other hand, Lorillard has also been first to move into the only domestic "tobacco" area that's actually growing -- e-cigarettes -- with their purchase of Blu. So that may balance out some of the regulation risk. Pluses and minuses ...

  • Report this Comment On May 26, 2013, at 11:53 AM, jaybird43 wrote:

    The possible banning of menthol cigs and other regulations you get in the US accounts for buying a company without those risks

  • Report this Comment On May 26, 2013, at 1:07 PM, mansourg54 wrote:

    PM growth comes from acquiring foreign tobacco companies. PM just bought the 20% remaining equity in Mexico tobacco that it did not own. Claiming that smoking is declining in the US but is on the rise abroad is meaningless. People are the same wherever you go and people around the globe have heard of the bad effects of tobacco. They arque as smokers in the US :"Is there anything in life that cannot be dangerous to you and to your health".

    MO is the best of all because of its high profit margins, high dividend, long history of dividend increase, its diversification and its ability to grow in other areas such as alcohol and financ

  • Report this Comment On May 28, 2013, at 1:14 PM, JodyCoconut wrote:

    The 4.8 percent yield you mention quickly drops to 4.08 percent if you have to pay a non-resident withholding tax. PM's dividends are not exposed to that. I also think you should have mentioned the payout ratio. PM has a lot of room to increase its dividends.

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