Pricing Power = Profits
Chad is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
In certain industries, the ability to price your product appropriately defines the winners and the losers. This is clearly the case in the tobacco industry. The two defining factors in successful tobacco-related companies are pricing and brand name. There is only one tobacco company that has both brand-name recognition and pricing power in growing regions that I'm aware of. That company is Philip Morris international (NYSE: PM). I've written in the past that this company could be considered the perfect stock. While some investors will not consider tobacco-related companies, if you can get past these reservations, Philip Morris is a dividend and earnings machine.
While competitors such as Altria (NYSE: MO), Lorillard (NYSE: LO), and Reynolds American (NYSE: RAI) struggle with regulations and lawsuits here in the United States, Phillip Morris has the advantage of growing in markets that are less regulated and with less threat of legal issues. With the company reporting earnings, we get a chance to go behind the scenes and see what's driving results. On the surface, overall results didn't look that great. However, investors need to go beyond the headlines to realize that this company is actually doing pretty well.
Philip Morris' overall results mirror an issue that I've noticed with other multinational companies -- currency fluctuations negatively affected both revenues and earnings. For instance, Phillip Morris' net revenues were down 1.8%, but excluding currency issues would have increased 2.9%. Similarly, diluted earnings were up 0.7%, but again excluding currency fluctuations would have increased 8.1%. While shipment volume overall decreased 1.2%, these are actually amazingly good results considering the economic turmoil overseas. In fact, to get an idea of this achievement we need to look at each geographic region to see how challenging the last quarter really was.
In the European Union, the company's revenue was down 0.7%, while earnings decreased 2.6%, and volumes were down 9.4%. In the Asian market, the company saw volumes down, which affected revenues and earnings as well. While volumes were down a small amount in Latin America and Canada, revenues actually increased by 6.3%. The bright spot of this earnings report was Eastern Europe, the Middle East, and Africa. This division showed revenue of 13.2%, earnings up 23.1%, and volumes up 5.1%. With just one of the company's primary divisions showing growth, for Phillip Morris to report positive EPS growth was quite an achievement. In addition, though the company's financials were not as impressive as last year, Phillip Morris did about as well as could be expected given the current climate.
The two most important numbers in Phillip Morris International's financial statements were free cash flow and share repurchases. The company's free cash flow was down 17.9%, but even with this decrease, Phillip Morris generated over $3.2 billion. Part of this cash flow was used to repurchase 17.8 million shares for a total of $1.5 billion, at the equivalent of $84.27 per share. A portion of the remaining free cash flow was used to pay the company's 3.5% dividend. With a free cash flow payout ratio of 41.41%, investors should expect that future dividend increases will be no problem for the company. Phillip Morris all but confirmed a positive outlook for this year with its forecasts for 2012.
The company expects full-year earnings of $5.10 to $5.20. This is about what analysts were predicting, which was $5.18 for the full year. In addition, the company expects to repurchase about $6 billion worth of shares for the year. The company also said it expects, “solid cigarette organic volume growth in 2012.” Last but not least, a new three-year share repurchase program of $18 billion is slated to begin Aug. 1. While there are other alternative investments in the tobacco industry, in my eyes Philip Morris International leads the way.
For instance, one could make the case for buying the original Phillip Morris, which is now called Altria. The difference between the two is Phillip Morris International has the ability to capitalize on the Marlboro brand name worldwide, while Altria is limited to the United States. While Altria does have a more attractive dividend yield, the market seems to be valuing the shares a little highly given the company's expected growth rate. With just 6% growth expected, the company is slated to grow slower than any of the competitors we've looked at.
Reynolds American has the highest dividend yield at 5.1%, but again the market is already highly valuing its expected 7% growth rate. Last but not least is Lorillard, which has the highest expected domestic growth rate at 9.55%. Lorillard also has the lowest free cash flow payout ratio of all four companies. If investors are looking for a good dividend yield from a company expected to grow at a decent rate, Lorillard seems like a good choice.
On the other hand, investors looking for international exposure should consider Philip Morris. With a nearly 10% growth rate and a competitive 3.5% dividend yield, the numbers look attractive. The company said that pricing power is one of their most important competitive advantages, and in this industry pricing is everything.
MHenage has no positions in the stocks mentioned above. The Motley Fool has no positions in the stocks mentioned above. Motley Fool newsletter services recommend 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. If you have questions about this post or the Fool’s blog network, click here for information.