Many investors might think that the growth of Philip Morris International (NYSE:PM) would slow down because of stricter regulations and a higher excise tax. Nomura Securities has downgraded the company with a target price of only $76 per share, a much lower price than the current trading price of $89.30 per share. However, there are several key strategies that could drive the business forward.
The business is still growing
Philip Morris is still enjoying good growth. In the third quarter, it reported diluted EPS of $1.44 per share--this was 9.1% higher than the EPS reported in the same quarter of last year. Excluding the currency impact, its operating companies income (OCI) increased by 3.3%, driven mainly by the Eastern Europe, Middle East & Africa (EEMA), European Union, and Latin America & Canada regions. The OCI of Asian business dropped by 1.7% due to unfavorable volume/mix of $106 million and higher clove prices in Indonesia. Including the currency impact, Asia's OCI plunged by 15.4%. To achieve better OCI growth, Phillip Morris will keep its focus on cost control and productivity initiatives.
Positive momentum in the premium segment
Philip Morris will focus on the profitable adult consumer segment to support its global market share expansion. The company has increased its market share in the international cigarette markets, from 25.5% in 2008 to 28.8% in 2012. The company will enhance its leadership position in the premium segment with the two premium brands, Malboro and Parliament. Its flagship brand, Malboro, has delivered good results and is gaining market share in many regions, including the EU, EEMA and Latin America and Canada. The Malboro brand will be reinforced by three main initiatives: three defined identities - "Flavor," "Gold," and "Fresh", customized consumer innovation, and its new "Be Malboro" marketing campaign.
Huge potential growth lies in China
The company thinks of China as a midterm potential growth driver, with its 2.5 trillion-cigarette market. According to the Wall Street Journal, China is the biggest cigarette market in the world and accounts for as much as 40% of the world's cigarettes smoked. However, Malboro has only 0.3% of the market share in China. Phillip Morris could unlock the Chinese market potential in the future by exploring more possible cooperation initiatives. These could be based on the long-term strategic agreements with China National Tobacco Corporation, the monopoly player in the Chinese cigarette market.
High cash return yields with a reasonable leverage ratio
Income investors should be quite excited about Philip Morris due to its juicy dividend yield and upcoming share repurchases. Since being spun off from Altria (NYSE:MO), Philip Morris has returned $32.4 billion in cash by repurchasing 539 million shares (more than 25% of the total outstanding at the time of the spinoff.) By 2015, the company expected to return an additional $18 billion, giving investors a sweet 12.55% buyback yield. Because Philip Morris borrowed money to buy back shares and the cash return has been exceeded the cash flow generated from business operations, its net debt to EBITDA (earnings before interest, taxes, depreciation and amortization) has risen to 1.62. Although the leverage ratio is higher than those of Atria at 1.24 and Lorillard (UNKNOWN:LO.DL), at 0.9, Philip Morris is still in the comfortable position with its strong and stable free cash flow generation.
U.S. competitors move to e-cigarette business
Altria, after spinning off Philip Morris, concentrates mainly in the U.S. market. With the tougher regulatory environment in the U.S., Altria has relied on innovative tobacco products to drive business growth. Recently, its subsidiary Nu Mark introduced the new MarkTen e-cigarettes in more than 3,000 stores in the Indiana test market and is ready to expand it into 2,000 additional stores in Arizona at the end of this year. However, Altria CEO Marty Barrington commented that it was too early to say anything about the numbers of e-cigarettes sales.
Lorillard also entered the e-cigarette segment with a different perspective. Unlike other tobacco players, Lorillard did not make its e-cigarette look like the traditional cigarette. Its product has a black tube with a blue light on it so it could be used under smoking restrictions. It also seeks to expand this business by acquiring the U.K. e-cigarette brand SKYCIG for $49 million. The company will pay an additional $49 million in the next three years if SKYCIG meets certain financial targets. This deal could help Lorillard expand its global footprint in the new and exciting e-cigarette business.
My Foolish take
Philip Morris, with the Marlboro flagship brand, has a global leading position in the tobacco market. Philip Morris will grow significantly in the long run, driven largely by its premium business and the huge potential Chinese market. Income investors should really consider Philip Morris for their portfolios, with a juicy 4.4% dividend yield and an enormous share buyback plan for the next two years. Altria and Lorillard have chosen a new avenue to drive growth: the e-cigarette industry. The success of the e-cigarette business could drive their operating performance, but it could take quite some time.