These 3 Headwinds Are Currently Buffeting Philip Morris

These three headwinds are currently holding back Philip Morris' growth.

Mar 31, 2014 at 11:41AM

As the world's largest tobacco company, Philip Morris International (NYSE:PM) is sought out by investors for the defensive nature of its business and sizable dividend payout. However, at present there are three strong headwinds facing Philip Morris, holding back growth; although peers Altria Group (NYSE:MO), Reynolds American (NYSE:RAI), and Lorillard (NYSE:LO) do not seem to have similar problems.

Currency impacts will hit growth 
Philip Morris' biggest concern over the next year will be the impact of unfavorable currency effects on its earnings. Philip Morris must convert all of its earnings back to US dollars, so the company has always reported some kind of currency impact to earnings. But 2014 is likely to be tougher than usual.

Thanks in part to the declining value of currencies in several of the company's key growth markets, such as Russia and Turkey, Philip Morris' management is guiding for a $0.71 per share negative currency impact for 2014. Most of this weakness is expected to stem from emerging markets, which will account for $0.45 per share of weakness; the weak yen will impact earnings by $0.20 per share, and other currencies will impact earnings by $0.06. These figures were compiled before the recent Russian crisis, so the final currency impact on full-year 2014 results is likely to be worse than the figures above.

Just to put these figures into some perspective, Philip Morris reported earnings per share of $5.76 for 2014, before the impact of currency. In comparison, Philip Morris peers Altria, Reynolds, and Lorillard have no currency exposure, so investors do not need to worry about instability within developing nations denting their dividend income.

Debt
A longer-term headwind that Philip Morris is facing is the management of its debt. You see, Philip Morris has borrowed more than it can afford in recent years. This is no secret, as the company acknowledged this fact at the Morgan Stanley consumer-goods conference in November.

As a result, after the completion of the company's current $18 billion share buyback, Philip Morris' management has stated that the company will reduce its buybacks to a "sustainable level" in an attempt to reduce debt. Management stated that a "sustainable level" was approximately the value of free cash flow after the deduction of dividends every year.

Still, what is of concern for shareholders now is figuring out how much cash Philip Morris can return to investors if it is not borrowing heavily and keeping its buybacks at a "sustainable level." Well, using data supplied by Morningstar, Philip Morris' free cash flow during 2013 was $9 billion, and dividends for the period cost $5.7 billion; so that leaves $3.3 billion for buybacks...or debt repayments.

Once again, all of Philip Morris' domestic peers appear to be in a more secure financial position than the tobacco behemoth. Indeed, according to Morningstar, at year-end 2013 Philip Morris had a debt-to-EBITDA, or earnings before interest, taxes, depreciation, and amortization, ratio of 1.8 times. Altria, Reynolds, and Lorillard had net debt-to-EBITDA ratios of 1.4, 1, and 1 times, respectively.

Illegal tobacco
Philip Morris has been fighting the rise of the illegal cigarette trade for some time. However, the recent drive by developed nations to introduce laws that prohibit the sale of cigarettes in branded packaging has made it much easier for the illegal market to operate. The full extent of this has recently been revealed within Australia, the first country to introduce these laws. A study by accounting firm KPMG found that in the one year that these regulations have been in place, illicit tobacco sales have increased by 1.5% to 13.3% of total shipments, while consumption of tobacco has not changed.

Along with plain packaging, the Australian government hiked excise taxes on cigarettes to the point that taxes now comprise around 63% of the price for a pack of cigarettes. In Australia, a single pack of 20 Philip Morris Marlboro cigarettes sells for around US $14, versus $1 in Vietnam and $2.30 in China; as you can imagine, this is not helping the battle against the illicit tobacco trade.

According to a recent report entitled "Asia-11: Illicit Tobacco Indicator 2012," an international study compiled by the International Tax and Investment Center and Oxford Economics, the volume of illicit cigarettes being smoked within developing countries is on the rise. For example, it is estimated that within many Asian markets, key regions of growth for tobacco majors, up to one-third of cigarettes are illicit.

While the issue of illegal tobacco is not limited to Philip Morris, the company's US peers are less exposed. Indeed, although it is suspected that 56.9% of all the cigarettes smoked within New York are illegally smuggled, they are usually smuggled from other states, keeping the profits in Altria's Lorillard's and Reynolds' pockets.

Foolish summary
All in all, these three headwinds are likely to impact Philip Morris' growth and investor returns over the next few years. Although as of yet, it is not possible to estimate how much the company will be affected. Still, for investors who are seeking a safer alternative, Philip Morris' US peers Altria, Reynolds, and Lorillard would make great alternatives.

Take advantage of this little-known government tax rule
Recent tax increases have affected nearly every American taxpayer. But with the right planning, you can take steps to take control of your taxes and potentially even lower your tax bill. In our brand-new special report "The IRS Is Daring You to Make This Investment Now!," you'll learn about the simple strategy to take advantage of a little-known IRS rule. Don't miss out on advice that could help you cut taxes for decades to come. Click here to learn more.

Rupert Hargreaves owns shares of Altria Group. The Motley Fool owns shares of Philip Morris International. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

1 Key Step to Get Rich

Our mission at The Motley Fool is to help the world invest better. Whether that’s helping people overcome their fear of stocks all the way to offering clear and successful guidance on complicated-sounding options trades, we can help.

Feb 1, 2016 at 4:54PM

To be perfectly clear, this is not a get-rich action that my Foolish colleagues and I came up with. But we wouldn't argue with the approach.

A 2015 Business Insider article titled, "11 websites to bookmark if you want to get rich" rated The Motley Fool as the #1 place online to get smarter about investing.

"The Motley Fool aims to build a strong investment community, which it does by providing a variety of resources: the website, books, a newspaper column, a radio [show], and [newsletters]," wrote (the clearly insightful and talented) money reporter Kathleen Elkins. "This site has something for every type of investor, from basic lessons for beginners to investing commentary on mutual funds, stock sectors, and value for the more advanced."

Our mission at The Motley Fool is to help the world invest better, so it's nice to receive that kind of recognition. It lets us know we're doing our job.

Whether that's helping the entirely uninitiated overcome their fear of stocks all the way to offering clear and successful guidance on complicated-sounding options trades, we want to provide our readers with a boost to the next step on their journey to financial independence.

Articles and beyond

As Business Insider wrote, there are a number of resources available from the Fool for investors of all levels and styles.

In addition to the dozens of free articles we publish every day on our website, I want to highlight two must-see spots in your tour of fool.com.

For the beginning investor

Investing can seem like a Big Deal to those who have yet to buy their first stock. Many investment professionals try to infuse the conversation with jargon in order to deter individual investors from tackling it on their own (and to justify their often sky-high fees).

But the individual investor can beat the market. The real secret to investing is that it doesn't take tons of money, endless hours, or super-secret formulas that only experts possess.

That's why we created a best-selling guide that walks investors-to-be through everything they need to know to get started. And because we're so dedicated to our mission, we've made that available for free.

If you're just starting out (or want to help out someone who is), go to www.fool.com/beginners, drop in your email address, and you'll be able to instantly access the quick-read guide ... for free.

For the listener

Whether it's on the stationary exercise bike or during my daily commute, I spend a lot of time going nowhere. But I've found a way to make that time benefit me.

The Motley Fool offers five podcasts that I refer to as "binge-worthy financial information."

Motley Fool Money features a team of our analysts discussing the week's top business and investing stories, interviews, and an inside look at the stocks on our radar. It's also featured on several dozen radio stations across the country.

The hosts of Motley Fool Answers challenge the conventional wisdom on life's biggest financial issues to reveal what you really need to know to make smart money moves.

David Gardner, co-founder of The Motley Fool, is among the most respected and trusted sources on investing. And he's the host of Rule Breaker Investing, in which he shares his insights into today's most innovative and disruptive companies ... and how to profit from them.

Market Foolery is our daily look at stocks in the news, as well as the top business and investing stories.

And Industry Focus offers a deeper dive into a specific industry and the stories making headlines. Healthcare, technology, energy, consumer goods, and other industries take turns in the spotlight.

They're all informative, entertaining, and eminently listenable ... and I don't say that simply because the hosts all sit within a Nerf-gun shot of my desk. Rule Breaker Investing and Answers contain timeless advice, so you might want to go back to the beginning with those. The other three take their cues from the market, so you'll want to listen to the most recent first. All are available at www.fool.com/podcasts.

But wait, there's more

The book and the podcasts – both free ... both awesome – also come with an ongoing benefit. If you download the book, or if you enter your email address in the magical box at the podcasts page, you'll get ongoing market coverage sent straight to your inbox.

Investor Insights is valuable and enjoyable coverage of everything from macroeconomic events to investing strategies to our analyst's travels around the world to find the next big thing. Also free.

Get the book. Listen to a podcast. Sign up for Investor Insights. I'm not saying that any of those things will make you rich ... but Business Insider seems to think so.


Compare Brokers