4 Things Philip Morris International Inc. Investors Should Notice

Shares of Philip Morris International (PM 1.32%) have rallied nearly 10% since the beginning of the year, easily outperforming the S&P 500's 1% decline. But after that run, some investors might be wondering if the tobacco stock is getting ahead of its earnings and valuations. Therefore, let's discuss four key things which may impact PMI's ability to keep rallying in the near future -- the strong dollar, its valuations, its suspension of buybacks, and overseas turmoil.

PMI's flagship Marlboro brand. Source: Pixabay.

1. The dollar's impact
PMI's sales come from overseas markets, but it reports earnings in U.S. dollars, which severely throttles its sales growth. A simple look at PMI's 2015 sales across the world reveals how badly the strong dollar hurts its sales.

Source: PMI FY2015 report. *East Europe, Middle East, Africa.

PMI's 2015 sales, excluding excise taxes, fell 10% annually, while diluted earnings per share fell 7.1%. But on a constant currency basis, sales actually rose 5.8%, while earnings improved a whopping 18.1%. PMI investors seem willing to ignore the strong dollar for now, but it's unclear if they'll be as forgiving if the dollar rallies even more.

2. The valuations
As I mentioned in a previous article, many big tobacco stocks seem to be getting overheated, likely due to their reputation as "defensive" consumer staples stocks. PMI's domestic counterpart, Altria (MO 1.77%), is up nearly 20% for the year, while its top rival Reynolds American (RAI) has gained about 6%. 

But if we compare PMI's P/E and PEG ratios against the ratios of its competitors, we'll notice that both PMI and Altria are trading at slight premiums to the overall industry, while Reynolds' ratios remain below industry averages.

Source: Yahoo Finance, as of March 25.

3. No more buybacks until the dollar behaves
Like many other U.S. companies, PMI previously spent a large portion of its free cash flow on buybacks to support earnings growth. In 2012, it authorized an $18 billion buyback plan for the next three years. PMI had spent $12.7 billion of that total by the end of 2014, but it didn't buy back any more stock in 2015, and has no plans to do so in 2016.

During last quarter's conference call (as transcribed by Thomson Reuters), CEO Andre Calantzopoulos stated that "it makes no sense to resume share repurchases" as long as currency headwinds remained strong. However, he noted that if the dollar weakens, the company would "revisit the issue." The good news is that even without the aid of buybacks, PMI believes that its 2016 earnings can rise 10% to 12% annually on a constant currency basis.

4. Overseas enemies
When Altria spun off its overseas operations as PMI in 2008, it assumed that it would deal with domestic litigation as PMI focused on overseas growth. But ironically, PMI has gotten tangled up in a web of lawsuits with various national governments.

In Latin America, the company is suing Uruguay for passing aggressive anti-smoking laws which drastically reduced the country's smoking rate over the past decade. It also sued Norway and Australia for, respectively, banning cigarette displays in stores and passing plain packaging laws, but eventually lost both cases. And it sued the British government over new plain package regulations, and the Thai government over proposals to increase health warnings on cigarettes. Earlier this year, the Thai government fired back and sued PMI for alleged tax evasion.

These protracted legal battles are costly, and generate lots of bad PR for the company. While it's unclear if that bad PR will impact sales, PMI's worldwide legal battles will likely escalate as more countries try to reduce their smoking rates.

Should Philip Morris investors worry?
As a PMI shareholder, I'm not terribly worried about these four issues yet. I'll still be keeping a close eye on the dollar's strength and its valuations, which could curb investor enthusiasm in the stock -- but for now, PMI still looks like a sound defensive play which pays a hefty forward annual yield of 4.2%.