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A Tobacco Giant Worth Your While
Posted by: Patricio Kehoe (IP Logged)
Date: January 27, 2014 05:06PM

The tobacco industry is one of the most profitable markets for investors, given its large margins and shareholder returns. However, these past few years governments all over the world have been tightening up on regulatory laws and raising taxes, therefore reducing consumer volume of cigarettes. But the largest tobacco company worldwide, supported by investment gurus Joel Greenblatt (Trades, Portfolio) and Mario Gabelli (Trades, Portfolio), has successfully sustained its product demand and steadily increased revenue. So, let’s take a look at its business model and what the future holds in store.

A Powerful Brand Portfolio and Emerging Market Presence

Phillip Morris International Inc. (PM) is the world’s largest tobacco manufacturer in the world, after China National Tobacco, and holds 29% of the entire industry’s market, outside the U.S and China. Most commonly known for its flagship brand, Marlboro (accounts for one-third of total volume), this firm also owns seven of the 15 international leading cigarette brands. Its supporting brands — L&M, Phillip Morris, Bond Street, Parliament, Chesterfield and Lark — have allowed the company to attain consistent growth margins over the past decade. Given its addictive product and global manufacturing and distribution system, this comes as little surprise.

While present in 180 countries, Asia, Eastern Europe, the Middle East and Africa are currently the key drivers of this firm’s revenue growth. Phillip Morris is likely to benefit from increasing sales in these regions, due to their growing populations, product consumer habits, rising income and looser restrictions on tobacco companies. As such, long-term revenue in expected to increase by 10% in Asia, and 5% in the remaining regions. Also, the firm’s international presence gives it a strong competitive advantage towards market rivals Altria Group Inc. (MO), Reynolds American Inc. (RAI) and Lorillard Inc. (LO). In addition to the popularity of its brands, Phillip Morris benefits from scale advantages, combined with the historically strong brand loyalty among smokers, earning the firm strong pricing power. This advantage has allowed revenue to nearly double since 2006, leaving its current level of $77.4 billion.

Regarding Taxes, Regulations and Margins

Despite recent anti-tobacco laws passed by the European Union and the Food and Drug Administration (FDA) in the U.S, the company’s pricing power has helped maintain its margins. In 2012, for example, Phillip Morris hiked prices on its products in Russia, Germany, Belgium, Canada, France, Greece and Spain, among others. Although the necessary measure caused substantial volume declines in these countries, consumers rapidly became accustomed to the increased prices, and returned to their habitual product consumption. Given the success of this strategy, the firm is likely to rely on it in Japan for 2014, where taxes are expected to increase yet again by 8%, after the 40% spike in October 2010.

Another profitable business opportunity may come from the company’s recent cross-licensing agreement with its parent firm Altria, regarding next-generation products. The deal will allow Phillip Morris to market Altria’s eCig products outside the U.S, while the parent firm commercializes the tobacco giant’s two heated tobacco products, Platform 1 and Platform 2, within the U.S. Platform 1 is meant to launch in 2014, and Platform 2 a year later, which should help the company branch out to changing consumer habits among smokers and generate further revenue. On another note, Phillip Morris’ shareholder returns should not pass unseen by investors. Since 2008, the company has returned $59.1 billion to its investors via share repurchases ($27.9) and dividends ($24), and currently holds a steady dividend yield of 4.39%.

Bottom Line

With an EPS growth of 16.90% — well above the industry’s average — and an impressive revenue growth of 12.80%, this tobacco giant holds all the right cards to sustain its industry leading position. Despite possible changes in consumer habits and tobacco regulation enforcements, I feel highly bullish about this firm's future growth, especially in the emerging markets.    

Disclosure: Patricio Kehoe holds no position in any stocks mentioned.

Guru Discussed: Joel Greenblatt: Current Portfolio, Stock Picks
Stocks Discussed: RAI, LO, MO, PM,
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