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Philip Morris Is a Leading Tobacco Maker in an Incredible Profitable Industry

June 14, 2014 | About:
ovenerio

ovenerio

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In this article let's take a look at Philip Morris International Inc. (PM), the global tobacco giant that sells cigarettes in over 200 countries, which manufactures and markets the number one cigarette brand: Marlboro.

Combined Power

Philip Morris and Altria Group Inc. (MO) have reached agreements to sell electronic cigarettes and other smokeless products. Philip Morris has exclusive rights to sell Altria's e-cigarettes (battery-powered devices that heats a liquid nicotine solution in a disposable cartridge and create a vapor that is inhaled) outside the U.S. On the other hand, Altria gains exclusive rights in the U.S. to other tobacco products developed by Philip Morris.

Further, both companies will work together to improve existing products. Altria and Philip Morris International produce and distribute Marlboro, the world's leading cigarette brand, with an admirable pricing power due to smoker’s fidelity. Altria sells Marlboro in the U.S. and Philip Morris sells Marlboro outside the U.S.

Marketing Campaigns

The company’s portfolio of international and local brands include Marlboro, Merit, Parliament, Virginia Slims, L&M, Chesterfield, Bond Street, Lark, Muratti, Next, Philip Morris and Red & White. Marlboro is the world’s best-selling cigarette brand and has been on the rise for years and we expect this to continue in fiscal 2015.

The company focuses on positive consumer reaction through the introduction of additive marketing campaigns. The “Don't Be a Maybe, Be Marlboro” marketing campaign renewed Marlboro's market share. The campaign has been introduced across 50 countries showing young and wild people acting in decisive ways. Although anti-tobacco campaigners accused the company of breaching its own ethical code with campaigns which clearly intended to gain new smokers, the effectiveness of the campaign had already been successful to take the desired action.

Because of the marijuana legalization in the state of Colorado and Washington, a website ran the story that Marlboro will start producing marijuana cigarettes, contacting former drug lords in Mexico and Paraguay (two of the largest marijuana-producing countries in the world) with a $15 billion advertising budget to promote the product to consumers in the beginning of 2015. The internet exploded but the problem was that it was fake news. But don't be surprised to see big tobacco companies turn into marijuana in the near future, with a “Marlboro M”. This example demonstrates that cigarette brands enjoy the highest brand loyalty of all consumer products.

Emerging Markets

The company plans to evaluate potential acquisitions or other business development opportunities in countries such as Indonesia, China, Philippines and Korea. Additionally, emerging markets are considered strategic markets due to the increase in customer´s disposable incomes. India, Bangladesh and Vietnam are potentially growth markets, too. Asian markets have been the best performing segment. The Asia region contributed almost a third of the 2013 profits and is seeing robust growth in Indonesia, China, Philippines and Korea. With respect to China, it represents a major concern because it has the largest tobacco industry in the world. Although the cigarette market is generally closed to foreign tobacco companies, the company entered into a joint venture with China National Tobacco to cross-sell products.

Shares More Valuable

Dividends have been paid since 2008 and consistently increased dividends every year. The last dividend increase was in September 2013, when the Board of Directors approved a 10.6% dividend increase to 94 cents per share. Philip Morris pays a dividend yield of 4.16%, and the company repurchased 15.4 million shares for $1.25 billion during the first quarter.

Relative Valuation and Price Performance

In terms of valuation, the company sells at a trailing P/E of 17.3x, trading at a discount compared to the industry mean.

Ticker

Company

P/E

RAI

Reynolds American Inc.

20.5

LO

Lorillard, Inc.

20.1

MO

Altria Group Inc.

18.9

PM

Philip Morris International, Inc.

17.3

BTI

British American Tobacco plc

17.3

This ratio indicates that the stock is relatively undervalued when compared to Reynolds American Inc. (RAI), Lorillard, Inc. (LO) and Altria Group Inc. So it seems to be an attractive investment relative to its peers [except for British American Tobacco plc (BTI)].

In the next graph we can see the evolution of the stock price together with EPS. The reason is that earnings often lead the stock price movement. As we can appreciate, the price performance and EPS showed an interesting upward trend in the last five years. A long position of USD 10K five years ago today represents USD 27,307 (which means a 22.3% annual return).

1402711346121.png

Final Comment

Governments are imposing restrictions to reduce smoking, but no matters the severity of laws or taxes, the tobacco industry is minimally affected by these regulatory issues.

Philip Morris has several drivers which we discussed above such as the strategic and licensing partnership, strong marketing campaigns and the strategic plans on key growth driving regions like Asia. Moreover, it is consistently buying back stock and it pays huge dividends to shareholders. The attractive dividend yield makes the company a perfect fit for any portfolio, because we know that stocks with higher dividend yields have historically outperformed stocks with lower dividend yields.

In this opportunity, I would recommend investors (not those that share Warren Buffett (Trades, Portfolio)'s moral thoughts) to consider adding the stock for their long-term portfolios.

Philip Morris has proven to be a good long idea in the past and should be so even in the future. Hedge fund gurus have also been active in the company in the first quarter of 2014. Joel Greenblatt (Trades, Portfolio) and Jean-Marie Eveillard (Trades, Portfolio) have taken long positions on it.

Disclosure: Omar Venerio holds no position in any stocks mentioned.

About the author:

ovenerio
We provide independent fundamental research and hedge fund and insider trading focused investigation.

Rating: 4.0/5 (2 votes)

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Comments

tfrates
Tfrates premium member - 4 months ago

What about that Treasury stock policy of the last 6 years ?

ovenerio
Ovenerio premium member - 4 months ago

Dear Colleague,

As you know, companies buy back their shares for a variety of reasons. One of those is that management believes the stock is undervalued and maybe the company plans to resell them when the stock price rises. To clarify this situation, in the balance sheet we have the "Treasury Stock" account, which will often has a negative number besides the treasury stock entry.

As you mention, over the past six years, the company has kept repurchasing its shares, as indicated in the next chart:

<a href="http://www.gurufocus.com"><img src="http://chart.gurufocus.com/1403140416782.png" /></a>

The level of treasury stocks is increasing over time, from $5.1 billion in 2008 to $32.1 billion in 2013.

By buying back its stock, Philip Morris reduces the number of shares outstanding, which in turn gives each shareholder a larger piece of earnings. Likewise, the lower number of shares can improve the EPS ratio and perhaps your question comes in this sense. So we have to take care of it, and continue monitoring this plan of repurchase in the future.

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