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Don't Give up on Philip Morris, the Company Still Has Plenty of Room for Growth

By Rupert Hargreaves – Jan 10, 2014 at 3:00AM

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Many investors have given up on Philip Morris as they believe the company's growth days are behind it, but I believe that there is still plenty of room for the company to expand.

At the end of last year, Philip Morris International's (PM 1.76%) management team revealed that the company's growth was going to be below its long-term target of 10% per annum during 2014. Specifically, management stated that 2014 was going to be a year of consolidation and expansion as Philip Morris broadened its influence into regions where its market share is less than that of its closest peers, British American Tobacco (BTI -0.48%) and Japan Tobacco (JAPAF 1.16%).

But some market commentators have questioned Philip Morris' forecasts. In particular, as the tobacco industry is in terminal decline, will Philip Morris be able to return to its long-term growth target of 10% per annum after this year of expansion?

British American and Japan Tobacco are Philip Morris' main competitors in the global tobacco market, and each company has its own regional dominance. For example, according to data from Tobacco Atlas, Philip Morris dominates markets such as Europe, much of Southern Africa, Mexico, and Argentina. Meanwhile, Japan Tobacco dominates the Russian and Japanese markets, while British American dominates the Brazilian and Canadian markets as well as much of Central Africa.

However, although these three behemoths dominate most of the global tobacco market, a large part of the industry is still controlled by state tobacco companies, or individual producers. If we look at data from Tobacco Atlas once again, we can see how the industry is changing in favor of Philip Morris.

For example, back in 2008, the year for which the most recent data is available, Philip Morris controlled 17.4% of the global cigarette market, up from 15.5% eight years earlier. British American's share of the market stood at 12%, up from 11% during 2000, and Japan Tobacco's share stood at 9.6%, up from 7.2% eight years before. It would appear that these tobacco giants were able to establish this growth through industry consolidation.

In particular, these giants have been acquiring smaller, regional, or local cigarette producers, which saw their share of the global cigarette market fall from 32.2% during 2000 to only 19% as of 2008. Testament to this consolidation strategy is Imperial Tobacco, the worlds fourth-largest tobacco company, which during the eight-year period from 2000 to 2008 saw its share of the global tobacco market rise from 0.8% to 4.9%. Imperial did this by acquiring smaller regional cigarette producers within the United States, Norway, Germany, France, the UK, Sweden, Canada, and Africa, all of which were previously independent.

Driving growth
This geographical expansion and consolidation are key features of Philip Morris' growth drive. For example, the company recently closed a deal to acquire 50% of a major cigarette company located within Algeria and purchased the remaining 20% of a joint subsidiary within Mexico. The Algerian cigarette market is still mostly state controlled, and although Philip Morris dominates the Mexican market, the company has, up until now, had to share its profits.

Out of reach
However, a region that currently remains out of reach for all tobacco companies is China. China is easily the worlds largest cigarette market and one that continues to expand. Philip Morris estimates that 2.5 trillion cigarettes have been sold within China during 2013, which is around 40% of the total volume of cigarettes sold worldwide.

Philip Morris is seeking to capitalize on this growth and the sheer size of the market through an agreement with China National Tobacco, which under license produces Philip Morris' Marlboro cigarettes. Philip Morris sold 2 billion units through this channel during 2012, nowhere near the full potential of this market.

Different strategies
On the other hand, as Philip Morris drives into new geographies, British American and Japan Tobacco are perusing different strategies to drive growth in their tobacco divisions.

British American, for example, is focusing on four 'global drive' brands, which reported sales growth of 1.9% for the third quarter of this year. The company's Dunhill brand led the increase, with shipment volumes rising 9.6%, and volumes of Pall Mall cigarettes shipped rose 5.2%. These brands generally have a lower price tag that some premium peers, and British American is seeking to capitalize on this.

Meanwhile, Japan Tobacco is slashing costs to widen profit margins. The company plans to cut 1,600 jobs and close four factories in Japan to boost profitability as cigarette demand slumps in the country. Luckily, Japan Tobacco is also benefiting from a weak Japanese yen.

Foolish summary
So all in all, the question as to whether or not Philip Morris can continue to grow depends upon the company's ability acquire smaller competitors. The tobacco industry is still highly fragmented, and Philip Morris can drive growth through acquisitions, which will, to some extent, offset the decline in cigarettes shipped within the company's developed markets.

Fool contributor Rupert Hargreaves has no position in any stocks mentioned. The Motley Fool owns shares of Philip Morris International. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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