Philip Morris Plans to Expand in Emerging Markets

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

Asian Markets

Profitability in emerging markets is a factor that differentiates the firm from its peers. For example, it has a strong presence in Asia. These markets are considered strategic markets due to the increase in customer´s disposable incomes and volumes are more stable, or even increasing.

The company plans new packaging and blends in these new markets. India, Bangladesh and Vietnam are potentially growth markets as well as China. In those, it accounts for approximately 40% of total international cigarette consumption as opportunities.

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.

In countries such as Indonesia, Turkey or the Philippines are higher levels of smoking due to more lax regulatory environment. This should help to slow the firm's decline in volumes over the next decade.

Dividend Increase

Dividends have been paid since 2008 and consistently increased dividends every year. It has recently announced the seventh consecutive annual dividend increase: a new annual dividend of $4.00/share ($1.00 per quarter, up 6.4% from previous $0.94).

Philip Morris pays a dividend yield of 4.44%, and it continues to do share repurchases on its three-year $18 billion buyback strategy.

Revenues, Margins and Profitability

Looking at profitability, revenues declined by 0.90% but beat the Zacks Consensus Estimate. Earnings per share decreased in the most recent quarter compared to the same quarter a year ago ($1.38 vs $1.44). During the past fiscal year, the company increased its bottom line. It earned $5.26 versus $5.18 in the previous year. For the next year, Wall Street expects a contraction of 3.6% in earnings ($5.07 versus $5.26).

Finally, let´s see a measure defined by Joel Greenblatt (Trades, Portfolio): the Return on Capital, which he analyzed it differently in his book “The Little Book That Still Beats the Market (Little Books. Big Profits)”. He defined Return on Capital as EBIT divided by the total of net fixed assets and net working capital.

The formula is: Return on Capital: EBIT/(Net Working Capital + Net PPE – Excess Cash)

So, let´s compare the ROC which is one of the most important measures of the efficiency of a business and should be an important tool for investors.

The ROC is higher than 85% of the 48 companies in the industry. Phillip Morris has a current ROC of 146.96% which is the higher than the industry median which is just the same as the one exhibit by British American Tobacco (BTI, Financial). During the past 10 years, the firm's highest Return on Capital was 196.99%, the lowest was 83.98% and the median was 118.03%.

It is very important to understand this metric before investing and it is important to look at the trend in ROC over time.

Relative Valuation and Price Performance

In terms of valuation, the stock sells at a trailing P/E of 17.2x, trading at a discount compared to an average of 19.3x for the industry. To use another metric, its price-to-sales ratio of 4.55x is above the industry average of 3.82x.

This ratio indicates that the stock is relatively undervalued when compared to Reynolds American Inc. (RAI, Financial), Lorillard, Inc. (LO, Financial) and Altria Group Inc. So it seems to be an attractive investment relative to its peers [except for British American Tobacco plc (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. As we can see in the next chart, the stock price has an upward trend in the five-year period. If you had invested $10.000 five years ago, today you could have $20.747, which represents a 15.7% compound annual growth rate (CAGR).

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, one of them are the 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 second quarter of 2014. Charles Brandes (Trades, Portfolio) and Ray Dalio (Trades, Portfolio) have bought the stock, while David Dreman (Trades, Portfolio), John Rogers (Trades, Portfolio), James Barrow (Trades, Portfolio), Tom Russo (Trades, Portfolio) and Jeremy Grantham (Trades, Portfolio) have taken long positions on it, as well as Hotchkis & Wiley and Diamond Hill Capital (Trades, Portfolio).

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