Is Philip Morris International Inc. Destined for Greatness?

Investors love stocks that consistently beat the Street without getting ahead of their fundamentals and risking a meltdown. The best stocks offer sustainable market-beating gains, with robust and improving financial metrics that support strong price growth. Does Philip Morris International (NYSE: PM  ) fit the bill? Let's take a look at what its recent results tell us about its potential for future gains.

What we're looking for
The graphs you're about to see tell Philip Morris' story, and we'll be grading the quality of that story in several ways:

  • Growth: are profits, margins, and free cash flow all increasing?
  • Valuation: is share price growing in line with earnings per share?
  • Opportunities: is return on equity increasing while debt to equity declines?
  • Dividends: are dividends consistently growing in a sustainable way?

What the numbers tell you
Now, let's take a look at Philip Morris' key statistics:

PM Total Return Price Chart

PM Total Return Price data by YCharts.

Passing Criteria

3-Year* Change

Grade

Revenue growth > 30%

11.1%

Fail

Improving profit margin

0.3%

Pass

Free cash flow growth > Net income growth

(9.5%) vs. 11.4%

Fail

Improving EPS

25.5%

Pass

Stock growth (+ 15%) < EPS growth

56.1% vs. 25.5%

Fail

Source: YCharts. *Period begins at end of Q1 2011.

PM Return on Equity (TTM) Chart

PM Return on Equity (TTM) data by YCharts.

Passing Criteria

3-Year* Change

Grade

Improving return on equity

Negative equity 

Fail

Declining debt to equity

Negative equity

Fail

Dividend growth > 25%

46.9%

Pass

Free cash flow payout ratio < 50%

70.2%

Fail

Source: YCharts. * Period begins at end of Q1 2011.

How we got here and where we're going
We analyzed Philip Morris on these metrics last year, and the internationally focused tobacco giant is holding its ground in its second assessment, since it mustered the same three out of nine possible passing grades it picked up in 2013. The company's slowing revenue and profit growth have hurt its progress, but Philip Morris has nonetheless pushed both top and bottom lines forward in a deteriorating environment for tobacco sales. However, dividend seekers have again pushed Philip Morris' stock growth beyond the gains in its net income. Will Philip Morris be able to sustain its dividend payments without hurting the financial health of its business? Let's dig a little deeper to find out.

Over the past few quarters, falling tobacco sales have become a difficult hurdle for Philip Morris to surmount, and investors have become more concerned about its future earnings growth. The company continues to pay a solid yield of 4.5%, which at current share prices represents roughly three-quarters of its average earnings estimates for the full year, above management's stated aims of maintaining dividend payout ratios at 65% of earnings for the coming years.

Fool consumer goods specialist Mark Reeth notes that Philip Morris boasts massive scale and brand power, with a share of roughly 28% of the global cigarette market. The company is also trading at a reasonable forward valuation when compared to some of its domestic peers:

PM PE Ratio (Forward) Chart

PM P/E Ratio (Forward) data by YCharts.

Philip Morris' profits grew at double-digit rates in Russia as the company raised its prices in line with rising Russian tax rates in the first quarter. The company's share of the Russian cigarette market also increased to 26.7%, in spite of (or perhaps because of) the introduction of harsh antismoking laws that ban smoking in public areas and set mandatory minimum prices for cigarettes. Motley Fool tobacco-sector specialist Rupert Hargreaves notes that Philip Morris expects its cigarette shipment volumes to decline by 9% to 11% in 2014, which will be offset by further price hikes. This drop seems driven by the European Union, which seems determined to curb cigarette use through higher excise tax rates. Philip Morris' EU cigarette volume already fell by 6.5% last year, representing a major risk to its revenue share as cigarette smugglers and counterfeiters proliferate on the Continent. Philip Morris foresees massive growth potential in the rising populations and increasing incomes of Asia, but it currently faces major short-term challenges in Japan and Indonesia due to fierce completion from regional cigarette makers.

Big tobacco companies are also investing hundreds of millions of dollars into developing "reduced risk" products. Philip Morris has ramped up its capital expenditures to bring innovative products to market within the next few years, and also commenced the construction of a 30-billion-unit HeatStick tobacco-stick factory at a cost of $800 million in Bologna, Italy, which is expected to be completed by the end of 2016. The company also plans to spend more than $100 million developing next-gen products, such as e-cigs, this year.

Putting the pieces together
Today, Philip Morris has some of the qualities that make up a great stock, but no stock is truly perfect. Digging deeper can help you uncover the answers you need to make a great buy -- or to stay away from a stock that's going nowhere.

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