Like most tobacco companies, Philip Morris International (PM 0.68%) pays a hefty dividend. Buy shares today, and you'll get more than 5% of your initial investment back each year in dividend yield.
That's a solid catch for income-focused investors, but the stock's been pretty disappointing otherwise. Today, the stock trades at the same price as a decade ago, so if you like some share price appreciation with your dividends, sorry!
But Philip Morris is a much different company today than even a year ago, and the irons it has in the fire signal a much brighter future for shareholders. Investors should consider adding Philip Morris to their portfolio for the next 10 years. Here's why.
Image source: Getty Images.
The Swedish Match acquisition changes things
Philip Morris began as the cigarette company with non-U.S. rights to Marlboro when Altria spun it off about 15 years ago. This locked Philip Morris out of a lucrative U.S. market. Additionally, the company still reports earnings in U.S. dollars, so all of its revenue must convert to dollars, often understating its performance. These two fundamental problems with Philip Morris' business model have a lot to do with the stock's underperformance.
But that's changing. Philip Morris spent $16 billion to acquire Swedish Match, the company behind the Zyn, a smokeless nicotine oral pouch. Zyn is the leading nicotine pouch brand globally and in the United States, where it holds a 64% market share.
Nicotine pouches aren't a big category yet, worth an estimated $2 billion globally late last year. However, the long-term potential is where it gets interesting. The category is rapidly expanding, growing volumes by 80% in 2021. Zyn's volume grew 47% year over year in the U.S. in Q1, the company's first since the acquisition.
Zyn could be a significant contributor to revenue five years out if the category continues growing at this pace and retains its leadership against On!, Altria's competing product.
The opportunity with heated tobacco products
The more immediate opportunity is in Philip Morris' IQOS heated tobacco product, which it's been selling in non-U.S. markets since 2014 and has become nearly 20% of its shipment volume (excluding Zyn). Philip Morris and Altria were once in a distribution agreement to let Altria market the product in America, but that is ending.
Meanwhile, Philip Morris has butted heads in court with British American Tobacco, which accused it of patent infringement surrounding IQOS, a battle that has prevented Philip Morris from importing IQOS into the U.S. market. So instead, Philip Morris is planning to use a different technology and manufacture its product in the U.S.
A U.S. presence could make a considerable difference to Philip Morris' bottom line. The company is essentially entering the world's second most lucrative tobacco market, making any incremental business gained there icing on the cake -- it won't cannibalize any of its existing business. Additionally, the influx of U.S. revenue should help offset the currency headwinds that have dragged down its financials for years.
While this won't be an overnight change or a flip of a switch, these moving gears could set up Philip Morris for the long term and begin driving meaningful earnings growth.
Keep an eye on the balance sheet
Philip Morris took out a lot of debt to buy Swedish Match, pushing its total debt to $47 billion, or 2.8X its earnings before interest, taxes, depreciation, and amortization (EBITDA). That's about as high as I generally feel comfortable with, but management has emphasized a desire to pay this down over the coming years.
One could argue the balance sheet is more an opportunity than a concern. Barring an unexpected move, Philip Morris sits pretty with Zyn and IQOS as the cornerstones for its post-cigarette business. Investors could eventually see share repurchases and more significant dividend increases as Philip Morris pays down debt. Furthermore, extinguishing debt will cut down on interest expenses, which will trickle down to earnings too.
PM Financial Debt to EBITDA (TTM) data by YCharts
Five years from now, Philip Morris could be a financially healthy, steadily growing cash cow pumping out dividends and delivering solid share appreciation. Yes, the past has been a disappointment for many, but the company's future looks as exciting as ever.
