Headwinds Make Headlines, But Growth Potential Remains
Reuben is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Philip Morris International's (NYSE: PM) first-quarter earnings were less than impressive. However, digging deeper into the numbers shows that the near-term problems shouldn't derail the company's long-term growth prospects.
“Philip Morris International Inc., the world’s largest publicly traded tobacco company, posted first-quarter earnings that fell more than analysts estimated as tax increases and economic weakness hurt shipments.” That was the first sentence of the Bloomberg article covering Philip Morris' first-quarter earnings report. Sounds pretty bad.
Even worse, the company lowered its full-year earnings forecast. On the surface, it looks like the international tobacco giant could have some trouble on its hands. Luckily, there's still a lot to like about the company's future.
About 30% of the company's revenue comes from Europe. That's a tough market right now because of the region's economic malaise. Since tobacco products are increasingly expensive, it isn't too surprising that sales comparisons would be weak. In fact, if you compare the relationship between unemployment and volume declines, there is a clear correlation.
For example, in Spain, where unemployment was a painful 26.1% in December of last year, tobacco industry shipments fell nearly 12% year over year in 2012. While that's the most dramatic example, similar trends hold true across the continent. France, Poland, and Italy all have unemployment rates that exceed 10%.
Once these economies get back on their feet, it's reasonable to expect results to solidify, if not improve.
Imperial Tobacco Group (NASDAQOTH: ITYBY.PK), with around half of its top line coming from Europe, will likely see a bigger impact on its top line. Although that hints at a bigger rebound when things go well, Philip Morris' greater diversification is why its shares are up for the year, despite a pullback in earnings, while Imperial's shares are down well over 10%.
Imperial's yield is higher than Philip Morris', but its greater exposure to slow-decline markets in Europe will remain a long-term drag on growth. That makes Philip Morris a better long-term option even after Europe works through its current unemployment problems.
The Philippines made headlines on the tax front in the first quarter, but it wasn't unexpected. A new tax law in that country is nothing short of draconian, increasing the sin tax on tobacco products by at least 60%. With a large market share there, Philip Morris is feeling the hit.
How big an impact was this one country's tax change? First-quarter shipments were down 6.5% overall, but down just 2.1% if you exclude the Philippines. Clearly, the over 40% drop in shipments in the Philippines due to the tax law change had a big impact on the company's overall performance.
Beyond this country, however, management reports that tax issues aren't overly hostile. However, this event shows why Philip Morris' business is exposed to more risk than its former parent, Altria (NYSE: MO).
Altria has the domestic rights to the same brands that Philip Morris sells internationally. It's a bit of an odd structure, but gives two investment choices: income and predictability versus growth and more volatility.
Part of this dichotomy is the mature nature of the U.S. market. The other part is that the U.S. tax structure is pretty much set. While Altria will see a long, slow decline in cigarette sales, it shouldn't see a sudden shock like that from the Philippines. That makes it more appropriate for conservative investors seeking income than Philip Morris International, which can provide higher growth but at increased risk.
Still, once the Philippines tax structure has been in place for a little while, results should stabilize. That will turn this drag into, at worst, a neutral issue.
The earnings revision
Perhaps the most interesting aspect of the company's announcement was its downward earnings revision. There, however, management was quite clear to point out that exchange rates were the culprit, not underlying performance. That's important to note as countries like Japan take aggressive monetary stances to boost their economies. In the end, exchange rates are not something within Philip Morris' control.
A good outlook
Despite what will likely be a challenging year in 2013, largely because of the Philippines tax law, Philip Morris still has a bright long-term future. With a more diversified business than companies like Imperial and Altria, material exposure to emerging markets, and a collection of leading brands, any sell off on 2013 results should be considered a long-term buying opportunity.
However, with only a few months of a tough year under its belt, more conservative investors may want to wait for lower prices before stepping in. Or, conversely, buying several small positions through the year just in case the market bids the shares up again after the first quarter-earnings shock wears off.
Tobacco companies have been under siege in the U.S. for decades, as waves of litigation, regulation, and anti-smoking campaigns have given the industry a black eye. Yet Philip Morris International focuses on overseas markets, where business prospects generally look brighter. Investors have been happy with its stock's performance, but is Philip Morris still a buy? Find out in The Motley Fool's premium research report on the company, which includes in-depth analysis of its opportunities and challenges ahead. To claim your report just click here now.
Reuben Brewer 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!