This is a guest post by Ben Reynolds. Reynolds founded Sure Dividend, which is dedicated to helping individual investors pursue a long-term investment strategy in high quality dividend growth stocks.
Philip Morris was a recent buy of Passive Income Mavericks and owned by Dividend Diplomats also. I’m long Philip Morris International as well. This article discusses the investment merits of Philip Morris International, including the company’s current valuation and future growth prospects.
Philip Morris is the largest cigarette stock in the world; it has a market cap of $120 billion. Philip Morris sells branded tobacco products internationally. The company’s flagship brand is Marlboro. Altria (Philip Morris’ parent company) sells the same branded tobacco products exclusively in the U.S. The businesses split about 7 years ago so Philip Morris could pursue a fully international strategy and Altria could pursue a different business strategy in the U.S.
Philip Morris operates in 4 geographical segment. Each segment is shown below along with the percentage of operating income each segment produces:
- Eastern Europe, Middle East, & Africa: 34% of total operating income
- European Union: 31% of total operating income
- Asia: 26% of total operating income
- Latin America & Canada: 9% of total operating income
As the bullet points above show, Philip Morris’ operating income is highly geographically diversified. The Eastern Europe, Middle East, & Africa segment is its largest based on operating income, followed closely by the European Union and Asia segments. Latin America & Canada generate the smallest portion of operating income for Philip Morris.
Fundamentals & Dividend Metrics
Philip Morris stock has an exceptionally high 5.1% dividend yield. Additionally, the company has a price-to-earnings ratio of just 16.3 and a payout ratio of 65%. The company maintains a fairly high payout ratio as it returns much of its cash flows to shareholders in the form of dividends. Philip Morris has paid increasing dividends for 31 consecutive years, including its history as a part of Altria.
Since separating from Altria, Philip Morris has grown revenue per share at 8.6% a year. Dividends have grown at more than 10% a year over the same time period. In addition, Philip Morris has a fairly low stock price standard deviation of 24%. The company ranks very highly using The 8 Rules of Dividend Investing thanks to its extremely high dividend yield, solid growth rate, fairly low payout ratio, and long dividend history.
Future Growth Prospects
Philip Morris is expecting an 8% to 10% currency neutral earnings-per-share growth rate in 2010, around the same growth rate the company has experienced over the last several years. Adding in the company’s 5%+ dividend yield gives investors an expected total return of 13% to 15%; not bad for a boring cigarette company.
Philip Morris is growing earnings-per-share despite operating in the slowly declining cigarette industry. Here’s how Philip Morris is growing in spite of lower cigarette volume:
- Market share gains
- Lower operating costs
- Higher prices
- Share repurchases and effective capital allocation
Philip Morris raises its cigarette prices whenever taxes increase. Since the demand curve for cigarettes is relatively inelastic (people keep buying them no matter the price – within reason), the company can raise prices more than cigarette tax increases, and increase its margins in the process.
Slowly declining cigarette volume has caused Philip Morris to analyze its operations and become more efficient. This has helped reduced operating costs for the company and increased margins further. Additionally, the company continues to slowly gain market share in many of its major markets around the world. This is due primarily to the company’s extremely strong Marlboro brand.
Finally, Philip Morris’ management is excellent at capital allocation. The company currently pays a 5% dividend yield. It has been taking on long-term debt with an interest rate at less than 4% and using much of these funds to repurchase shares. This is a prime example of excellent capital allocation. By borrowing money at less than 4% and repurchasing shares that the company pays 5% on, it is increasing current cash flows while simultaneously reducing share count.
Additional Growth Prospects
In addition to Philip Morris’ core business growth, the company has other growth prospects that could speed growth in the future. The company is working in tandem with Altria (makes you wonder how ‘split’ the companies really are) to develop heated tobacco products. The new brand of heated cigarettes and e-cigarettes could be the future of the industry. Adoption rate has been slower than expected, but the category is still growing rapidly. If these new categories take off, Philip Morris could potentially benefit greatly.
Philip Morris is a perfect example of a high quality business trading at a fair price (if not slightly undervalued) with a very shareholder friendly and competent management team. The company has an expected total return of 13% to 15% a year from dividends (5%) and earnings-per-share growth (8% to 10%). This is a great company to buy for long-term oriented investors looking for both capital appreciation and high current income.
Disclaimer: This post is meant for educational or informational use only. Before making any investment, please do own research and consult with an investment professional or tax professional.
Thanks for reading.