Simplifying the Case for Philip Morris International

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Philip Morris International (NYSE: PM) is the largest publicly-traded tobacco company in the world. Owning seven of the fifteen leading international brands, the company has amassed a market capitalization of roughly $150 billion. This equates to the 18th largest company in the S&P 500. The company has marketed and sold products internationally since 1954 and currently derives 100% of sales outside the United States.  In the stock’s five years since it split from Altria, it has averaged an 18% annual return, versus just 5.4% for the S&P 500. Should investors buy the stock now or do mediocre returns lie ahead?

Best of breed

Philip Morris International has the number one market share in the European Union, Asia ex-China, Eastern Europe, the Middle East, and Africa, and the number two position in Latin America. China remains a closed market with China National Tobacco operating as a monopoly. Philip Morris International not only holds leading positions, but continues to incrementally gain market share. 

*British American Tobacco has not reported fiscal year 2012 results. 2011 numbers were used as a proxy.

Philip Morris International is a cash machine and despite the turmoil the industry has faced, returns on invested capital are exceptional. Philip Morris International is the best in the tobacco space and well ahead of other large cap consumer product companies. British American Tobacco (NYSEMKT: BTI) is the second largest publicly traded tobacco company and is a viable investment option as well. The chart below shows that Philip Morris International has been a much better allocator of capital in recent years. Philip Morris International has continued to grow profits without having to increase capital. The company has instead leveraged the balance sheet and used the proceeds to buy back stock. British American Tobacco has done a good job growing ROIC during a very difficult period as well. Still, Philip Morris International has been much better is this regard.

Another differentiating factor between the two companies is where they are positioned within emerging markets. Both have a sizable position in Western Europe and Russia. British American Tobacco’s next largest market is Brazil. Brazil is the sixth largest cigarette market based on consumption, but volume growth has declined by 10% in the last four years. Philip Morris International dominates Indonesia and the Philippines, where volumes are up 23% and 14%, respectively, in the last four years. Indonesia is now the fourth largest cigarette market behind China, Russia, and the U.S.    

 

Beat the market by minimizing drawdown

According to Ned Davis Research, the tobacco sub-industry group has produced an excess return of 15% relative to the S&P 500 during economic recessions since 1925. This is the sixth best among the 55 sub-industries with sufficient data. 

Shares of Philip Morris International currently have a dividend yield of 3.5% and a commitment to heavy share repurchases. This, along with broad global diversity, supports the notion that the stock can continue to be a long-term winner by minimizing drawdown during recessions and bear markets.

Reasonable valuation

The graph below shows the EV/EBITDA of Philip Morris International and three other core consumer product companies. As can be seen, at 11 EV/EBITDA the stock is priced at a discount to both Procter & Gamble as well as Coca-Cola. This likely reflects the constant regulatory cloud that encompasses Philip Morris International. Peer British American Tobacco (not shown) currently has an EV/EBITDA of 12.1.

PM EV / EBITDA TTM data by YCharts

Foolish bottom line

Philip Morris International offers an attractive core holding for any investor’s portfolio. Outperformance going forward will be driven by Asian growth, which can more than offset declining cigarette volumes in developed markets. The stock is reasonably valued, although one shouldn’t expect a lot of multiple expansion. Instead, investors should anticipate an above average and growing dividend along with high single-digit earnings per share growth. This best of breed stock could trail the market during big upswings, but more than makes up for that during bear markets. Buy and hold accounts should find the stock especially appealing.


market8 has no position in any stocks mentioned. The Motley Fool owns shares of Philip Morris International. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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