Jim Simons Bet on a Tobacco Giant With Weak Volume but Long-Term Growth

Philip Morris shows a solid average dividend growth rate

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Jun 21, 2017
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Philip Morris (PM)'s performance was below expectations in the first trimester as a consequence of the low volumes in Europe.

Specifically, first-quarter performance was characterized by diluted earnings per share of $1.02, up by 4 cents or 4.1% versus 98 cents in the same period of 2016. But adjusted diluted earnings per share of 98 cents were flat versus first-quarter 2016 and missed consensus by 5 cents. Moreover, revenue of $6.06 billion, down by 0.3% year over year, also missed consensus by $410 million.

The reasons behind these weak numbers are the 9.4% decline of total cigarette and heated tobacco unit shipment volume of 178.0 billion and the 11.5% cigarette shipment volume of 173.6 billion units. On the other hand, heated tobacco unit shipment volume of 4.4 billion units was up from 453 million units. As a consequence, operating income was down by 3.1% to $2.4 billion. Nonetheless, the company raised full-year guidance to EPS of $4.84 to $4.99, up from $4.80 to $4.95.

The company has several attractive intangibles assets such as brand loyalty and pricing power. There exist major risks related to regulation that affect margins depending on the level of taxation. To offset this, the company needs to take advantage of scale efficiencies. Its leading brands include Parliament, Virginia Slims and Chesterfield and, of course, the world’s best-selling cigarette brand, Marlboro. This one has been on the rise for years, and we expect this to continue in the near future.

Another major risk is related to its functional currency: the euro. About a quarter of its costs are denominated in euros; nearly 70% to 80% of its revenue is in that currency. But Philip Morris reports in U.S. dollars so a scenario in which the dollar strengthens can affect the company's earnings negatively.

Heated tobacco will be the principal alternative to smoking because it is the best option to almost replicate the smoking sensation. Further, this consumption switch should provide long-term growth.

Track record

Dividends have been paid since 2008, and the policy was to increase them every year since the spinoff by Altria Group (MO, Financial). The average in the last five years was almost 8%. The board of directors declared a regular quarterly dividend of $1.04 per common share.

Relative valuation and price performance

In terms of valuation, the company sells at a trailing price-earnings (P/E) of 26.67x, trading at a premium compared to the industry mean.

Ticker Company P/E
RAI Reynolds American Inc. 28.62
MO AltriaGroup Inc. 10.44
BTI British American Tobaccoplc 22.32

This ratio indicates that the stock is relatively undervalued when compared to Reynolds American Inc. (RAI, Financial) but overvalued when compared to Altria Group and British American Tobacco (BTI, Financial).

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. The price performance and EPS showed an interesting upward trend in the last five years. A long position of $10,000 five years ago represents $16,504 (a 9.9% annual return)Ă‚ today.

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Final comment

Although governments are imposing restrictions via regulations to reduce smoking, Philip Morris has several catalysts which we discussed above as well as an attractive dividend yield that makes the company a perfect fit for any portfolio.

Hedge fund gurus were active in the company in the first quarter. Jim Simons (Trades, Portfolio) has taken long positions on it. He upped his stake by 165.6% to 1.93 million shares.

Disclosure: Author holds no position in any stocks mentioned.