International tobacco giant Philip Morris International (NYSE: PM ) was a popular stock among investors when the company's shares first became available through a spinoff from former parent Altria Group (NYSE: MO ) in 2008. Yet over the past couple years, Philip Morris investors have seen the impressive share-price gains they enjoyed from 2009 to 2012 come to an abrupt halt, and the stock has actually started to give up ground even when taking its generous dividend into account. Despite concerns among shareholders that its best days might be behind it, Philip Morris International has plenty of upside potential in anything other than a worst-case scenario. Let's look at three of the key factors that could push Philip Morris stock higher.
1. The U.S. dollar could weaken.
One huge problem that Philip Morris International has faced lately is that the U.S. dollar has been relatively strong. That's bad news for the international giant, as its global business brings in foreign currencies of all types as revenue. Specifically, Philip Morris gets more than 60% of its revenue from Europe and Asia, and therefore when the euro, Japanese yen, and other regionally important currencies are weak, their value falls when translated back into U.S. dollars.
A strong dollar pulls down Philip Morris International's results substantially. In the second quarter alone, unfavorable currency impacts lopped off $0.15 per share from the tobacco company's earnings -- more than 10% of total adjusted diluted earnings for the quarter. When you remove the impact of the U.S. dollar, overall revenue went from down 1.5% to up 4.5%.
There's no guarantee that the strength in the U.S. dollar won't continue for years to come. The European economy remains weak, and policymakers in Japan have embraced measures to reduce the value of the yen. Yet currency movements tend to occur in cycles, and better earnings when the dollar next weakens could bolster confidence in the stock.
2. The trend toward industry consolidation could continue.
When competitive pressures flare up, industries often go through periods of consolidation, giving larger companies the opportunity to buy up smaller rivals and thereby return the level of competition to a more comfortable equilibrium. For instance, over the past decade within the U.S. airline industry, large-scale mergers giving the remaining players greater pricing power and returning them to profitability.
The recently proposed merger of Reynolds American (NYSE: RAI ) and Lorillard (NYSE: LO ) signals some of the same factors affecting the tobacco industry. If approved by regulators, the Reynolds/Lorillard combination would unite the two companies' best brands and help the combined entity focus its efforts on its most profitable products. With a number of regional players across the globe, the potential for Philip Morris International to extend its reach by buying up competitors in key markets is much larger than it is for U.S. tobacco companies. Major players such as British American Tobacco are too large to consider as potential merger partners, but lesser-known foreign companies could bolster Philip Morris' results and optimize its geographical exposure. Last year's moves to acquire stakes in ventures with exposure to Algeria and Russia are just a couple examples of what Philip Morris could do in the future; if the company can grow as a result, investors should reward it with a more attractive valuation.
3. Regulatory pressure could ease.
Most of the reluctance among Philip Morris investors to send share prices higher has to do with an increasingly hostile regulatory front. Australia's plain packaging laws haven't done much to curb smoking overall, but they have eliminated some of the willingness among Australian smokers to pay up for premium brands like Philip Morris' Marlboro. Already, Philip Morris has seen some margin pressure as a result of the need to discount its cigarettes to compete effectively. Similar fears about electronic cigarette regulation could curb what many see as a promising growth niche for the company.
At the moment, investors appear ready to extrapolate Australia's heightened regulation to other countries as well. Yet while some nations have jumped on the regulatory bandwagon, others still give Philip Morris International freer rein to take advantage of a growing consumer middle class. If the company has the same success fighting those challenges as Altria and U.S. companies did in battling lawsuits throughout the 1990s, then shares could easy rise from here.
Philip Morris International hasn't given shareholders a lot to cheer about lately. But if some of the things that have held back the stock start giving way to more normal conditions, Philip Morris investors could finally see better days ahead.
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