Tobacco probably isn't the first industry you think of when looking for massive returns in the stock market, but that might be a mistake. The nicotine business is chock-full of affordably priced companies poised for long-term success. Let's examine the reasons why tobacco giant Philip Morris International (PM 3.83%) could be a slam-dunk investment.
New growth drivers
Tobacco sales are falling in developed regions like North America and Western Europe. But Philip Morris plans to counteract this trend by focusing on reduced-risk tobacco products like the IQOS -- a heated tobacco system that releases less harmful chemicals than traditional cigarettes, according to company research.
In July, the U.S FDA authorized IQOS's marketing as a "modified risk" tobacco product, clearing the way for Philip Morris to license the platform in the U.S. through its partner, Altria Group (MO 0.70%).
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Philip Morris is also investing in another heated technology called TEEPS, which uses a carbon heat source to release tobacco flavor and nicotine, as well as a vaporizer technology called STEEM, that produces an inhalable nicotine salt. The company's heated tobacco unit shipment volume grew 18.7% to 19 billion units in the third quarter and reduced risk products, in general, now make up roughly 23% of its net sales, year to date. Overall, year-to-date net revenue totaled nearly $29 billion.
According to a 2019 press release, Phillip Morris aims to eventually replace its cigarette business with less-risky alternatives. Over the long term, this strategy could create new growth opportunities for the company and improve the public's perception of its brand. But in the near term, Phillip Morris is still dealing with the lingering effects of the coronavirus pandemic, which dampened demand in the third quarter.
Total shipment volume fell 7.6% because of a 9.8% decline (to 165 billion units) in cigarette volume. But this was partially offset by the previously mentioned 18.7% growth in heated tobacco unit volume to 19 billion. Management expects at least 5% net revenue growth and 8% adjusted EPS growth when COVID-19-related headwinds abate. And the rollout of vaccines around the world could make this happen sooner rather than later.
A compelling valuation
Philip Morris expects an adjusted EPS of $5.05 to $5.10 for the full year of 2020, representing 5% to 6% organic growth from the prior year and giving the stock a price-to-earnings ratio of just 16. Phillip Morris's multiple is slightly higher than it's U.S counterpart Altria Group, which trades at 9.6 times adjusted EPS.
Phillip Morris' deserves a higher valuation because of Altria's exposure to troubled vaping start-up, Juul Labs, which could pose future legal challenges to the company and expose it impairment charges. Phillip Morris doesn't face this regulatory overhang, potentially making its shares a safer bet. Philip Morris also offers a $4.80 per share annual dividend, which comes out to a yield of 5.95%. And the company has grown its distribution for 12 consecutive years.
Philip Morris is a buy
Everyone wants a good deal in the stock market, and Philip Morris offers just that. The tobacco giant is counteracting cyclical declines in the cigarette industry by pivoting to reduced-risk tobacco products. And its relatively low valuation makes it an excellent pick for value-oriented investors. The massive dividend is icing on the cake.
