More Headwinds for This Tobacco Master

Waqar is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

On July 18, the world’s largest publicly-traded tobacco company, Philip Morris International (NYSE: PM), reported its earnings for the second quarter. The company missed its earnings’ estimates by $0.11, mainly due to currency fluctuations.

With the tobacco industry facing an uncertain future, the question is: What is in store for Philip Morris?

Quarterly earnings

In its second quarter, Philip Morris posted earnings of $2.12 billion, or $1.30 a share, falling 8% from the same quarter, last year. Excluding excise taxes, sales declined by 2.5% to $7.9 billion. Earlier, analysts at Thomson Reuters had forecast a profit of $1.41 per share on $8.17 billion revenue.

According to the company, Europe’s weak economy, unfavorable currency fluctuations and high excise taxes were the reasons behind a 6% decline in shipments. As Philip Morris only operates outside the U.S., a strong dollar compared to other currencies shrank company’s revenues. China’s slow economic growth also led to a lesser demand of cigarettes.

In Eastern Europe, Middle East and Africa, shipments were down by 3.6%. In Canada and South America, total shipments decreased by 2.4%. Due to a recent tax increase in Philippines, volume fell 3.5% in Asia.

Revenue slipped 3.5% in the EU and 5.7% in Asia. However, South America and Eastern Europe saw a revenue jump of 1.1% and 1.4% respectively.

Costs associated with manufacturing and selling of cigarettes increased 1% to $2.7 billion. Cigarette shipments fell 4% to 228.9 billion cigarettes amid volume declines across the globe.

Profit guidance

After posting its second-quarter results, Philip Morris also lowered its full-year profit guidance. The company now expects to earn $5.43 to $5.53 per share, down from its April guidance of $5.55 to $5.65. In the next quarter, analysts expect Philip Morris to earn $1.45 a share on total revenue of $7.99 billion. For the full year, analysts’ expectations stand at $5.46 per share on $31.55 billion revenue.

Going forward

The long term future of Philip Morris depends largely on global economic conditions and the U.S. dollar. With China reporting a second consecutive quarter of slow economic growth, cigarette demand is bound to remain low in the country. Just like China, Europe’s economic downturn would result in meager revenues for the company. Further, more taxes and smoking bans across the EU won’t help the cause either. As more and more people are getting health-conscious in East Asia, Philip Morris isn’t expected to grow significantly over there. As there are no major smoking bans in Africa, South Asia, and Latin America, the company would be able to increase its volume in these regions.

During the last few months, the Australian dollar (AUD) has lost more than 10% of its value, relative to the U.S. dollar. As a result, Philip Morris has suffered a lot in the Australian region. As AUD keeps on losing its value, things don’t look better for the company. A weak Yuan would further reduce Philip Morris’s profits in China. The same is the case with South Asian and African currencies. However, a stronger Yen and Euro would enhance company’s income to some extent. Thanks to a stable Canadian dollar, the North American region looks better.

Tobacco industry’s major players

Recently, British American Tobacco (NYSEMKT: BTI) completed a joint venture with I.M.U Enterprise in Myanmar that would enable it to manufacture, distribute and market its products in the local market. The company has plans to invest $50 million in the project during the next five years. According to British American Tobacco, this project would help the company in regaining a significant market share in the country.

British American Tobacco is trading at a forward Price/Earnings (P/E) ratio of 14.40 and yields a high dividend of 5.40%. It has a Price/Earnings to Growth (PEG) rate of 1.71 and a Price Earnings to Growth for the Year (PEGY) of 1.1, making it one of the most undervalued stocks in its industry. A mean recommendation of 2 on the sell side reflects that it’s one of the better buys in the tobacco industry.

On the other hand, the American holding company, Vector Group (NYSE: VGR) reported a 7% decline in its revenues during the first quarter, 2013. One of the main reasons behind this low revenue was a 10% decline in company’s unit sales. However, its operating income increased 23% to $43.1 million. One of the hallmarks of Vector is its super high dividend yield of 9.70%. Further, its cash per share ($4.83) is almost three times its current annual dividend, depicting its strong liquidity. Therefore, it’s a great buy for dividends.

Conclusion

Philip Morris International will be successful in increasing its volume across Africa, South Asia and Latin America. However, with the U.S. dollar going strong, Philip Morris won’t be able to mint substantial incomes during the second half of 2013. In addition, weak economic conditions in Europe and China would further weaken its growth prospects. In short, I remain neutral on Philip Morris International.


Waqar Saif 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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