Source: Flickr user Fried Dough.
To be frank, sin stocks, or companies that focus on immoral or unethical business products or services, aren't for everyone. As an investor, you need to be able to believe in the business you're buying into, and for some investors, tobacco, alcohol, gambling, and firearms manufacturers, for example, simply aren't business models they can support.
On the other hand, sin stocks can be very profitable, as most sin products or services are quite addictive. In addition, while sin stocks aren't completely masked from the effects of a recession, they tend to perform quite well during economic downturns and rarely lose their pricing power.
With that in mind, today we'll turn our attention to tobacco producer Philip Morris International (PM 2.58%) and analyze whether or not it would be a good sin stock to buy.
Philip Morris getting smoked
Just because Philip Morris is a sin stock doesn't mean it isn't without flaws. Before we dive into what might make the company attractive to investors, let's have a look at a few of its shortcomings.
Source: Flickr user Morgan.
First and foremost, cigarette volumes around the world remain challenged. In its recently reported third-quarter report Philip Morris noted that cigarette volume dipped 0.4% to 222.3 billion units as it contends with a regulatory pushback against tobacco products in some of its more developed countries, as well as cigarettes entering from the black market in areas like Southeast Asia, which are pressuring its margins.
Secondly, Philip Morris is dealing with unfavorable currency translation as the U.S. dollar continues to strengthen. In the latest quarter, the company announced a whopping negative currency impact of $0.20 per share against its EPS and saw operating income fall 5.5%. Excluding this, operating income actually rose 4.6%!
Lastly, there are clear concerns from investors in this volatile market over companies that are carrying high debt balances. As of the end of September, Philip Morris, though profitable, was lugging around $28.8 billion in debt and just over $2 billion in cash. In fact, the company has so much debt that its book value is actually negative, which could easily steer certain value investors away.
The allure of Philip Morris
Of course, Philip Morris has a lot to offer long-term investors as well.
To begin with, Philip Morris can avoid a lot of the regulatory scrutiny that tobacco producers deal with in the United States. Philip Morris strictly operates in ex.-U.S. countries, giving it the opportunity to sell tobacco products in stricter nations like Australia as well as higher-growth countries like India and China, where tobacco regulations are considerably more relaxed.
This geographic diversity not only allows the company to reduce its regulatory risk by spreading it around, but it also allows Philip Morris' strategy to remain fluid so it can focus on emerging market territories that give it the best chance to grow over the long run. India and China, for example, have a rapidly growing class of middle-class young adults who are eager for small luxuries, including the ability to smoke premium tobacco products.
Source: Flickr user Asim Bijarani.
Another key point here is that Philip Morris possesses a well-recognized premium brand in the Marlboro franchise. In fact, according to Philip Morris, it sells seven of the 15 best-selling internationally sold brands, and lays claim to 28.3% of total market share in China. When a brand is as recognized as Marlboro, the need to advertise isn't nearly as important.
Also, one of the primary allures of Philip Morris is the company's premier dividend. Because tobacco is such an addictive substance, the company and investors can, within reason, predict how much Philip Morris will earn in profits and generate in free cash flow on a quarter-to-quarter basis. It also doesn't hurt that tobacco producers can make up for lower cigarette volumes with their incredible pricing power. Combined, Philip Morris' steady profits have led to what is currently a mouthwatering 4.6% yield, which is more than two times higher than the average yield for the S&P 500.
Can you win with sin?
Now that we have a better idea about the challenges Philip Morris is facing, as well as its potential promise for investors, let's return to our initial question and determine if you can indeed win with sin stocks.
While I do suspect tobacco regulation is only going to tighten as time passes, especially in more industrialized and developed countries, the sheer number of markets Philip Morris operates in (more than 180) should allow it more than ample opportunity to offset regulatory weakness. Remember, the key to Philip Morris' success is a burgeoning middle class in emerging markets, and frankly, a number of territories it operates in simply haven't even reached that level yet. This implies Philip Morris could have decades of growth potential in front of it, if not from a volume growth perspective, at least from a pricing standpoint.
PM Dividend Yield (TTM) data by YCharts.
Also, Philip Morris' dividend is absolutely stunning. Although further increases may not be on the table for the time being, the simple fact that it's returning an estimated 79% of its 2014 profits to shareholders is impressive, and further demonstrates management's commitment to boosting shareholder value.
So, to answer our initial question, yes, I believe there's room for this sin stock in your portfolio as long as you understand that it's a long-term investment, and it could face short-term rough patches due to regulatory or currency actions.
