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Philip Morris: The steady growth business over time

July 30, 2011 | About:
Philip Morris (PM) had announced the higher Q2 results. In the filing of the company, it has noted it has the favourable growth of business in Asia region, especially in Indonesia and the impact of the business combination in the Philippines, however, that growth has been offset by Japan market, due to a lower total market, and Pakistan, due to a lower tax-paid market resulting from an increase in illicit trade. PM continues to post its higher revenue resulting mainly from the price increase and the favorable currency exchange rate.

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Looking at its 05 year operating performance, the revenue, the operating income as well as the net income keeps increasing at the very steady rate year on year. The gross margin has improved from 61% to 65%, the operating margin and net margin fluctuates around 38% - 41% and 25-28% respectively.

2005 2006 2007 2008 2009 2010
Net Margin (%) 28.08 29.56 26.43 26.8 25.33 26.68
Asset Turnover 0.87 0.84 0.78 0.79 0.74 0.78
Financial Leverage 2.24 1.83 2.08 4.4 6.04 10
Return on Equity (%) 54.53 50.02 40.62 60.17 95.97 157.43


For its profitability, Philip Morris posted the impressively increasing in the return on equity. That increase in ROE is mainly due to the increase in the financial leverage, whereas the net margin and asset turnover are not improving, or even posts the slight decrease.

Screening its balance sheet, the increase in financial leverage due to three main factors: the increase in short- term debt as well as long-term and the increase in treasury stock, which the company uses its fund to buy back its shares over years. The first two former items often makes value investors like us cautious, and the latter one is more likely to be welcome.

2005 2006 2007 2008 2009 2010
Net income 5620 6146 6026 6890 6552 7498
Operating cash flow 5158 6236 5589 7935 7884 9437
Capital expenditure -736 -886 -1072 -1099 -715 -713
Free cash flow 4422 5350 4517 6836 7169 8724


PM keeps producing increasing free cash flow, and the operating cash flow growth is more than the net income PM generates over the last 05 years. With quite stable capital expenditure, the operating cash flow and free cash flow is quite in line with each other. The Free cash flow currently stands at US$8.7 billions, with the current market value of $127 billion; the P/FCF is at 14.6x.

The current free cash flow yields of 6% and the free cash flow is anticipated with high probability for growing seems quite reasonable, it is not cheap price for PM, however, with its long established brands as well as with very loyal customers, PM can be considered the reasonable stock to hold for long-term with reasonable gains over years. The risks are always on the regulations on smoking and the litigation that the company is currently facing.


This is the subjective viewpoint of the author, it is not the recommendation to buy, hold or sell any stock. The person who wishes to do so should conduct his/her own research, act on his/her own decision, and bear his /her own risks.

About the author:

Anh Hoang
Money manager into global equities, especially with US and Vietnam markets. CFA level 3 candidate. Lecturer for Stalla - CFA course in Vietnam

Visit Anh Hoang's Website


Rating: 4.4/5 (23 votes)

Comments

cm1750
Cm1750 premium member - 2 years ago
Nice analysis.

Leverage has gone up but is very manageable. PM mgmt is smart in terms of FCF allocation. The company issued low rate debt as the after-tax rate was much lower than the non-tax deductible dividend yield on the shares they bought with the proceeds so it is a fantastic arbitrage.

I have owned Altria/PM for years and for the first time I actually think the company is finally close to fair value at the current $70. That being said, it is probably still a decent risk/reward at current prices.
ken_hoang
Ken_hoang - 2 years ago
Hi Cm1750,

Thanks for your comments and your info. haven't noticed the debt rate they issued are low though. The leverage has gone up and the equity has been pushed down due to shares buybacks. And the FCF increases overtime.

How 'bout Altria business? could you say sth more 'bout it?

Thanks

Anh
cm1750
Cm1750 premium member - 2 years ago
I bought Altria in 2003 but sold MO and KFT after the spin, keeping PM.

In May, PM issued $1Bn of debt at an average of 3.1% or 2% after tax. Using it to buy back shares with an 7%+ earnings yield of 4% dividend yield is a no brainer.

Pricing power is very good and they have an addictive product that is benefiting from emerging market growth.

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