Philip Morris International (NYSE:PM) returned 146% in stock price increases and dividends over the last five years. That's an average of nearly 30% per year. Clearly, investors who owned Philip Morris for any significant length of time during the last five years made out pretty well. Unfortunately, two new developments have emerged to make future returns less certain. All Philip Morris investors need to know about these two things before deciding whether to hold or sell their stock.
Persistent currency headwinds
Philip Morris' stock price ended last week nearly 7% lower than it began after the company issued a press release warning that its 2014 performance would not be as good as was previously anticipated. In the release, CEO Andre Calantzopoulos cited currency headwinds and weak economic conditions as the primary factors for lowering 2014 earnings per share guidance to $4.87 to $4.97 instead of the previously announced $5.09 to $5.19.
Currency headwinds are nothing new for Philip Morris. The company's 2013 results were negatively affected by a weak euro and Asian currencies relative to the U.S. dollar. Philip Morris derives 61% of its revenue from the European Union and Asia, making currencies in these regions important drivers of dollar-denominated profits. Unfavorable exchange rates lowered earnings by 6% in 2013, and a strengthening dollar could cause an even bigger negative impact in 2014. However, currency impacts are a normal part of Philip Morris' business, and investors should not be too concerned about the company's long-term earning power because of a few bad years of exchange rate fluctuations.
Trouble down under
The press release also cited a far more troubling development as a partial cause for the lowered guidance: heavy discounting in Australia. On the 2013 year-end conference call, Calantzopoulos noted that while Australia's plain packaging laws had no impact on smoking rates, generic packaging caused smokers to trade down to value brands. In last week's press release, Calantzopoulos warned that persistent price discounting at the low end of the Australian market could cause earnings per share to come in closer to the low end of the revised range, suggesting that generic packaging would have a material adverse effect on the company's results.
Although the jury is still out on generic packaging's effectiveness as a tool to reduce smoking rates -- and there's evidence that its effect is the opposite -- Philip Morris' premium brands could lose their pricing power if plain packaging laws spread beyond Australia. The company derives the majority of its revenue from high- and mid-priced cigarettes, so a loss of pricing power would be a significant value-destroyer for Philip Morris shareholders.
What to make of it
Currency headwinds, weak economies, and crippling regulations have conspired to reduce Philip Morris' profit outlook. If the company hits the mid-point of its new guidance -- $4.92 per share -- earnings per share will have declined 1.9% from 2013 to 2014 after adding back $0.24 per share charges related to shutting down cigarette production in the Netherlands. However, after adjusting for currency impacts, earnings per share is expected to grow 6% to 8% based on the updated guidance.
Investors need to decide for themselves which measure is most accurate in describing Philip Morris' earning power. Exchange rates are somewhat unpredictable and largely out of the hands of management, but investors who believe the U.S. dollar will strengthen as the Federal Reserve's liquidity programs are rolled back may be hesitant to ignore adverse currency fluctuations. At the same time, generic packaging laws are so far contained to Australia and New Zealand, but Ireland will soon follow. Investors who believe generic packaging will become the norm may want to dump their Philip Morris stock at 17 times 2014 earnings guidance.
On the flip side, 17 times earnings is a reasonable price for a stock growing earnings per share at 6% to 8%, making the stock appealing for investors who believe the currency headwinds and generic packaging do not represent long-term threats to Philip Morris' earning power.
Philip Morris could be a buy or a sell depending on your views regarding a few key factors. Intelligent minds can disagree on whether the dollar will continue to strengthen and plain packaging laws will continue to spread. The most important thing is that Philip Morris investors frame the investment correctly. Decide what your views are on these key issues to develop a strong justification for holding -- or selling -- your Philip Morris stock.