Philip Morris International (NYSE:PM), the global tobacco leader in emerging markets, has been known as a consistent growth business that has been paying increasing dividends. However, since the beginning of the year Philip Morris has lagged the S&P 500 significantly. Year-to-date, it has only risen 4.16%, much less than the S&P 500's return of 21.93%. Many investors worry about stricter regulations in many emerging markets and the company's huge debt burden. However, there are three reasons to be bullish about this company in the long run.
Keep buying back shares
Since being spun off from Altria (NYSE:MO) in the beginning of 2008, Philip Morris has significantly increased its debt position. While short-term debt rose from $584 million in 2008 to $3.94 billion in June 2013, long-term debt shot up from $11.38 billion to nearly $21.56 billion during the same period. Interestingly, Philip Morris has taken advantage of low-interest debt to buy back shares. Stockholders' equity is quite negative at nearly -$5.5 billion, whereas treasury stock has accumulated to nearly $29.2 billion. In the near future, because of Philip Morris' sluggish year-to-date share price performance, I would expect that this share buyback will continue, supported by the company's cash flow generation.
Highly leveraged? Actually, no
As mentioned above, many investors are afraid of the company's high debt level and the negative equity. However, I personally do not think the high debt level is detrimental to the performance of the business. Why? Because Philip Morris has been generating growing cash flow over time. In the past five years, free cash flow increased from more than $7 billion in 2008 to more than $8.5 billion in 2012. In the trailing twelve months, its EBITDA, or earnings before interest, taxes, depreciation and amortization, reached nearly $14.45 billion. Consequently, net debt/EBITDA stayed at only 1.56. This leverage ratio is not significant at all compared to peers like Altria and British American Tobacco (NYSE:BTI). While Altria's net debt/EBITDA was around 1.31, British American Tobacco's leverage ratio stayed in the middle of the three companies at 1.44.
The biggest potential for cigarette companies, including Philip Morris, lies in China. According to the Wall Street Journal, China is considered the biggest global market and accounts for 40% of the world's cigarettes smoked. However, Philip Morris' flagship brand Marlboro has only a 0.3% share of the Chinese market. British American Tobacco's brand 555 ranks second with 0.5% share. Philip Morris has seen that innovative products with new technology are the only way to expand its business in China. For instance, the company mentioned that it is developing vaccines for the Chinese market via Medicago. However, investors should be patient because it will take years for a vaccine to go through clinical trials and approvals.
British American Tobacco is also diversifying into less harmful smoking products. It recently began selling an e-cigarette with the brand name Vype in the UK. First, it will be sold only via the internet. In the near future, the products might also be distributed via traditional retailers as well. Altria, which operates mainly in the U.S. with stricter regulations, considered the e-cigarette to be the main driver for business growth. Via its subsidiary NuMark, the MarkTen e-cigarette has been introduced to the U.S. market. In order to create brand awareness, the company uses a premium point of sale at retail. In the future, Altria will focus on developing more superior e-cigarette products, broad retail distribution, and building brand equity to keep the e-cigarette business growing.
My Foolish take
With a 4% dividend yield, growing cash flow, and reasonable leverage, Philip Morris is definitely suitable for long-term income investors. Moreover, in the long run, if the company can expand its innovative products in the Chinese market it could have huge future growth potential.