Philip Morris International's (NYSE:PM) CEO, Andre Calantzopoulos, recently dumped more than $3.4 million worth of stock at a lower price than the stock trades today. On top of this, the secular headwinds faced by cigarette manufacturers has many investors rightly afraid to invest in tobacco companies like Philip Morris and competitor Altria Group (NYSE:MO). The CEO's stock sale is just one more reason to believe that Philip Morris' future is not as good as its stock price suggests. Should investors take it as a sign that it's time to ditch Philip Morris?
CEO dumps stock
According to an 8-K filing with the SEC, on May 12, Calantzopoulos sold 40,000 shares of Philip Morris stock, or about 5% of his total stake. The proceeds from the sale totaled $3.4 million -- more than most people make in a lifetime. Moreover, Calantzopoulos has a pattern of selling $2 million to $3 million in stock each year. He has sold $8.5 million worth of stock in the last three years. The pattern will likely continue next year.
There are many reasons that Calantzopoulos would sell his stock; he might need cash to buy a house or want to diversify his retirement savings. The only reason that should concern investors is if Calantzopoulos is selling because Philip Morris' earning power is in decline. Since investors cannot read the CEO's mind, the only way to gauge Philip Morris' earning power durability is to evaluate it for oneself.
Reasons to be concerned
There are many reasons to believe that Philip Morris' earning power is on the decline. The company derives 30% of its operating income from the European Union -- a region that is doing its best to stamp out cigarette consumption. European Union excise taxes often exceed 60% of the price of cigarettes, much higher than the 40% average tax in the U.S. This means that Philip Morris keeps a smaller share of revenue from each cigarette and represents a larger reward for smugglers and counterfeiters, who avoid taxation.
Moreover, European Union cigarette consumption fell by 25% from 2000 to 2010 -- an alarming drop for such an addicting product. Philip Morris' European Union volume declined 6.5% in 2013; the only other geography with a bigger decline also happens to be Philip Morris' largest segment: Asia. These are troubling trends that -- when combined with CEO stock sales -- could make any investor concerned about Philip Morris' future.
Not as bad as it looks
Fortunately, there are many reasons to be optimistic about Philip Morris' future. First, 2013 shipment volume declined much faster than will likely be the case going forward. A big tax hike in the Philippines, combined with selective enforcement of the tax, was responsible for the bulk of the 7.7% decline in shipments to Asia. Excluding the tax hike, Asia volume declined just 2.7%. Philip Morris' first-quarter results already show improvement, with Asia and European Union volumes declining less than 3%.
Philip Morris' competitive advantages should enable the company to grow shareholder value for many more years. The company owns the world's most popular cigarette brand, Marlboro, and captures a 28% share of the global cigarette market, excluding China and the U.S. Philip Morris' premium brands retain market share despite rising prices, enabling the company to grow profits even as volumes shrink.
In the face of volume declines, Philip Morris expanded its operating margin and increased earnings each year since it was spun off from Altria until a rough year in 2013. Still, last year's operating margin and operating income were much higher than just five years prior, indicating that the company's ability to raise prices more than compensates for volume declines.
Moreover, Philip Morris benefits from rising populations in developing nations, which are driving increases in global cigarette consumption. Even though per capita cigarette consumption is falling, the sheer number of people in low- and middle-income nations is causing total consumption to increase. This gives Philip Morris an opportunity to grow volumes in emerging economies.
An attractive stock
In addition to having strong defenses against an erosion in earning power, Philip Morris' stock price is cheap relative to Altria. Although not geographically diverse, Altria is Philip Morris' closest comparable company because of its market dominance. Altria's flagship brand, Marlboro, outsells the next 11 brands combined. Marlboro gives Altria the same pricing power in the U.S. as it gives Philip Morris internationally.
However, Altria's lack of geographic diversification and declining U.S. cigarette consumption gives Altria a slightly worse outlook than Philip Morris. Despite its shortcomings, Altria trades at 19 times trailing earnings compared to just 17 times for Philip Morris. Both trade at about 15 times analyst estimates for fiscal 2015 earnings. At the very least, Philip Morris does not appear to be overvalued relative to its closest peer.
There are many reasons why Calantzopoulos might sell stock, but it does not appear to be related to Philip Morris' business prospects or its stock price. Philip Morris' pricing power offsets volume declines in developed nations, while population growth supports volume increases in emerging nations. This gives Philip Morris a solid foundation for creating shareholder value. Finally, the stock is priced in line with Altria -- a close peer that operates in a less desirable market. As a result, investors need not follow Calantzopoulos' lead by selling Philip Morris.