Back in April 2009, I pitched Philip Morris International
The good, the bad, and the unfiltered
Valuation is essential when developing an investment thesis, but price-to-earnings ratios are meaningless unless considered in conjunction with a company's business fundamentals. Below, I've highlighted key aspects of Philip Morris' operations, separated into clear pros and cons.
Burning bright
- My colleague Colleen Paulson recently detailed the beginning of what looks to be the company's rebound. The main point here is that Big Phil's cigarette volume rose 0.5% in 2009's fourth quarter, or 0.4% when excluding acquisitions. Earlier in the year, that metric wasn't looking so hot.
- The recent volume gain is modestly encouraging in absolute terms, yet it's a total blowout compared with the mid-to-high single-digit declines turned in by domestic players Lorillard
(NYSE: LO) and Reynolds American(NYSE: RAI) , and the 11.4% rout suffered by former parent Altria(NYSE: MO) . - In the third quarter of 2009, Philip Morris' volume performance lagged that of global competitor British American Tobacco
(NYSE: BTI) , whose markets include the U.S. However, for the full year and the fourth quarter, Philip Morris edged out its rival (based on organic volume), once again proving the benefit of operating with zero exposure to the U.S. consumer. - Finally, Philip Morris' recent dividend increase and its massive $12 billion share-buyback program speak to both management's confidence and the likely stability of future shareholder returns.
Ashes to ashes?
But selling tobacco products on the international stage is not a risk-free enterprise.
- I previously described the demand-killing effects of government-mandated excise taxes -- a headwind that Philip Morris, as a global player, is hardly escaping. Since then, Japan has announced a major tax hike, and Philip Morris recently told investors that excise taxes are among the "key factors" influencing net revenue.
- Also acknowledged by management is the threat posed by the World Health Organization's Framework Convention on Tobacco Control -- essentially a worldwide tobacco cessation program that's expected to prompt "significant regulatory developments" in coming years.
- China, India, Bangladesh, and Vietnam comprise some of Philip Morris' key growth markets. As such, an investment in Philip Morris is essentially a bet on the ongoing health of these emerging economies. While investors' expectations for these nations routinely transform the stock performance of commodity names such as Freeport-McMoRan Copper & Gold
(NYSE: FCX) and Vale(NYSE: VALE) into a chutes and ladders game, Philip Morris shares should exhibit less volatility. Nonetheless, if emerging-markets growth stalls, I expect that governments will turn to tobacco as a tax cash cow, much as developing Eastern European nations such as the Ukraine have.
Pinning down a price
Management expects currency-neutral earnings-per-share growth of 12% to 15% in 2010, followed by 10% to 12% long-term currency-neutral EPS gains.
Given the external risks -- taxes, regulation, and foreign exchange -- I'm not comfortable putting anything higher than a 15 P/E multiple on 2010 estimates. Assuming the high end of company guidance, that gives us a target price of roughly $57 a share.
With shares changing hands at $52.50 today, plus the 4.5% dividend yield, investors could pull in a mid-teens total return, versus what I judge to be at least 10% downside in the event of negative developments.
All told, Philip Morris is indeed a buy, although not a strong one.
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