Shares of Philip Morris International (PM +2.10%) rose 4% on Oct. 18 after the tobacco giant posted third quarter numbers that topped analysts' expectations. Its revenue rose 0.4% year over year to $7.5 billion, beating estimates by $330 million. And taking out an unfavorable currency impact of $213 million, its revenue actually rose 3.3%.
On the bottom line, PMI's adjusted earnings grew 13.4% to $1.44 per share, beating estimates by $0.16. Excluding an unfavorable currency impact of $0.09 per share, its adjusted EPS would have risen 20.5%.
Image source: PMI.
For the full year PMI expects its revenue to rise approximately 3% on a constant currency basis, and for its earnings to grow 8% to 9% on the same basis. Unlike many of its industry peers, PMI isn't repurchasing any shares to buoy its EPS growth since volatile currency fluctuations can offset those gains.
PMI's growth looks stable, and it pays a hefty forward dividend yield of 5.4%. The stock trades at a reasonable 17 times this year's earnings, and its valuations cooled down considerably after the stock's 20% decline over the past 12 months. But is PMI a smart investment in a shaky market?
What the bulls say...
The bulls will likely note that PMI's shipments are steady, its market share is rising, and that it's reporting sales growth across the world as it expands its margins. PMI's total shipments of cigarettes and heated tobacco units (iQOS devices and HEETS/HeatSticks) fell 2.1% annually during the quarter. But excluding the net impact of trade inventory movements, its shipments actually rose 1.1%.
For comparison, PMI's domestic counterpart Altria (MO +1.22%) reported a 7.6% drop in shipments of smokeable products during its first half of 2018. Excluding the impact of trade inventory movements, its shipments still dropped 5.5%. PMI and Altria both regularly hike their prices to offset softer shipments -- but based on those figures, PMI doesn't need to employ that tactic as aggressively as Altria.
PMI also grew its market share from 38.1% to 38.4% between the first nine months of 2017 and 2018 as the growth of secondary brands like L&M and HEETS offset the weakness of its flagship Marlboro brand. For comparison, Altria's market share in cigarettes slipped from 51% to 50.2% between the first six months of 2017 and 2018 due to softer sales of Marlboro cigarettes in the United States.
Image source: PMI.
On a regional basis, PMI reported growth in combustible product sales across four of its six markets during the third quarter: the EU, Eastern Europe, South/Southeast Asia, and East Asia/Australia. That growth offset its declines in the Middle East & Africa and Latin America & Canada regions. But on a constant currency basis PMI reported positive growth across all six regions.
PMI's adjusted operating margin of 42.1% during the quarter also marked an improvement from 41.3% in the prior year quarter. The company attributed that expansion to lower sales of the iQOS devices (which it sells at lower margins to generate sales of higher-margin HEETS/HeatSticks) and lower manufacturing costs for its cigarettes.
What the bears say...
The bull case for PMI looks solid, but the bears will argue that tougher competition, tighter regulations, a stronger dollar, and rising interest rates could hurt the company.
The biggest near-term threat for PMI is British American Tobacco (BTI +2.07%), which eclipsed PMI as the largest publicly traded tobacco company in the world after its acquisition of Reynolds American. Several analysts think that PMI needs to recombine with Altria to stay competitive -- and that PMI will need to pay a significant premium to acquire Altria, which has an enterprise value of $127 billion.
PMI also faces tougher anti-smoking regulations and waning smoking rates in several markets. The company has been countering those moves with its own lawsuits (sometimes suing entire countries), but it's still destined to face shipment declines over the long term -- which would eventually put it in the same boat as Altria.
Lastly, a stronger dollar -- which should grow stronger with more interest rate hikes -- will throttle PMI's reported earnings growth and prevent it from initiating buybacks. Higher interest rates will also cause investors to swap high-yielding dividend stocks for bonds, which will hurt "classic" income plays like PMI and Altria.
The verdict
I think the bull case for PMI is stronger than the bear case, but I also think tobacco companies aren't reliable long-term investments because they have a shrinking core market. With the market constantly getting hammered by trade war jitters and concerns about interest rates, it makes more sense to stick with telco, utility, or big pharma stocks for comparable dividends with less drama.
