After it occupied a space near the top of my watchlist for a long time, I finally took the opportunity to add shares of global tobacco giant Philip Morris International (PM 3.83%) to my portfolio this week. I like the resilient nature of the company's business -- most smokers aren't going to stop buying cigarettes just because of inflation or an uncertain economic environment. I also like its valuation and its compelling dividend yield.
But there are plenty of consumer staples stocks one can buy for those reasons, and I know skeptics are saying: "That's great, but you bought a melting iceberg." I also view Philip Morris as a technological leader with some exciting growth drivers in its arsenal, which I'll outline below.
Image source: Getty Images.
Port in the market storm
Philip Morris is a fairly defensive and recession-resistant stock because people buy its products routinely and habitually. It's best-known for its Marlboro brand, which is the top-selling international cigarette. This defensiveness has been borne out by the numbers this year. While the S&P 500 and NASDAQ are down 17% and 24% year to date, respectively, Philip Morris is flat.
Philip Morris managed to grow revenue 4.2% year over year in the third quarter of 2022, a time when many companies across sectors have struggled and seen falling sales. Philip Morris also trades at a reasonable valuation of 15 times next year's earnings.
The stock also pays out an awesome, market-trouncing dividend that yields 5.6%. Philip Morris has increased this dividend every year since becoming a public company in 2008 (when it was spun off from Altria), and the annual dividend payout has increased by 171% since that time.
In addition to this compelling dividend payout, the company has a $7 billion share buyback program that it enacted last year, which will also return capital to shareholders.
The Tesla of tobacco
Philip Morris' resilient business model and generous dividend were very appealing to me -- but there's more to investing than simply playing defense all the time. Rupal J. Bhasali, the CIO of Ariel Investments and its portfolio manager for International and Global Equities, calls Philip Morris "the Tesla (TSLA 1.85%) of tobacco," illustrating the innovation and technological prowess that the company also brings to the table.
Philip Morris is a leader in smoke-free, heated tobacco products, such as its IQOS brand of devices which heat, rather than burn, tobacco. The IQOS line has been a home run for the company -- as of the current quarter, Philip Morris reports that there are 19 million IQOS users worldwide, with 1.1 million added during the most recent quarter. Nearly 70% of these users quit smoking and were using IQOS instead.
Philip Morris reported that IQOS had an 80% share in the 64 markets where it operates. Note that the product is not yet approved in the United States. If Philip Morris is able to gain approval, it would unlock a huge market for IQOS.
Even without the United States, the market opportunity ahead remains large, with Philip Morris estimating that there are 600 million legal-age nicotine consumers outside of China and the U.S. Obviously it won't capture all these customers, and this includes markets it's not yet in, but it illustrates the long growth runway ahead.
The advent of IQOS also hits back at the notion that Philip Morris is a "melting iceberg" because of its core cigarette business. In fact, the company's goal is for over 50% of revenue to come from smoke-free products by 2025, up from 24% in 2020. Even better, the net revenue per pack on heat sticks, the consumables that go into an IQOS device, is higher than for a pack of cigarettes, as are the gross margins. Rather than a melting iceberg with shrinking revenue, this could be a company that grows revenue and earnings for years to come.
In pursuit of Zyn
While the growth of IQOS is exciting, Philip Morris isn't stopping its transformation there. It's in the process of acquiring Swedish Match (SWM), a peer best-known for its Zyn nicotine pouches. The acquisition would give Philip Morris an even stronger leadership position in smokeless tobacco and nicotine products, as about two-thirds of Swedish Match's revenue is from smoke-free products.
Zyn has been a smash hit so far; it's the No. 1 brand in the fast-growing nicotine pouch category both in the U.S. and abroad. Philip Morris expects this category to expand at a scintillating 30% to 40% compound annual growth rate (CAGR) internationally over the next five years. It can use its large international footprint and distribution network to further accelerate Zyn's growth worldwide, while using Swedish Match's U.S.-based sales force to expand IQOS in the United States if and when it's approved for use.
It should be noted that it's not yet certain the deal will close, because it still awaits approval from Swedish Match's shareholders. But if Philip Morris can get the deal done, I think this will be another major growth engine for the company and further burnish its "Tesla of tobacco" image.
Looking ahead
Philip Morris is a company with a resilient business model that's proving it can thrive even during challenging economic conditions. It has a reasonable valuation and a substantial, market-beating dividend yield. These aspects inspire confidence that it's a solid addition to my portfolio, and I am also enthusiastic about the growth of the company's smoke-free products like IQOS and potentially Zyn, if it can complete the Swedish Match acquisition.
