Philip Morris (PM), through its subsidiaries, manufactures and sells cigarettes and other tobacco products. The company has paid and consistently increased dividends every year since being spun-off from Altria Group (MO) in 2008. The last dividend increase was in September 2013, when the Board of Directors approved a 10.60% dividend increase in the quarterly distribution to 94 cents/share.
Earnings per share have doubled over the preceding 7 years to $5.17 in 2012. The company expects earnings to reach $5.37-$5.42 per share in 2013, followed by a 6-8% increase in 2014. Despite the near-term slowdown in earnings per share, the company is committed to growing currency neutral EPS by 10-12% per year after 2015.
The company spends a large portion of cash flow on stock buybacks. Between 2008 and 2013, the number of shares outstanding has decreased from 2.116 billion to 1.614 billion. When a company buys out one out of four shareholders at attractive prices, this makes remaining shares more valuable as each stock certificate has a higher share of the total earnings pie.
Growth in earnings per share could be derived from acquisitions or organically. Phillip Morris has a high exposure to emerging markets, where number of smokers is increasing, along with their disposable incomes. This would offset decreasing volumes in developed countries in Western Europe, due to the Euro Crisis coupled with tough bans on smoking. The company can also squeeze out costs through efficiency containment programs.
Philip Morris can also increase revenues by acquiring other companies in strategic markets. It has a proven track record of making acquisitions work, and making them accretive for shareholders. If the company manages to enter China on a large scale or through a partnership with the state owned company, this would be very beneficial for shareholders also.
Unfortunately, the Chinese market is generally closed to foreign tobacco companies. It is estimated that a quarter of the Chinese population smokes, and that China’s mostly state owned tobacco industry accounts for 40% of the global tobacco market entirely through its domestic operations. China and Vietnam also present untapped opportunities for next generation products, such as Next Gen 1, which heats tobacco rather than burning it in order to derive the nicotine dose to the consumer.
As a company that reports in US dollars, but does business all over the world, Philip Morris results are affected by fluctuations in currencies. Over time however, I view those as a wash.
PMI has a strong moat, because it would be extremely difficult for a new company to start and compete against the long established brands like Marlboro. Consumers generally stay with the brands they are used to buying. Cigarettes are an addictive product, which spots very good pricing power. In addition, PMI has the economies of scale which ensure that its costs stay low relative to the competition.
However, we have all heard that tobacco products could be dangerous to people’s health. Tobacco companies face a lot of hurdles such as increased restrictions on where people can smoke, increasing excise taxes, illicit smuggling of product, and increased hostility against it by governments. Those risks are widely known, which is why tobacco companies are usually cheap. That makes share buybacks particularly beneficial for long-term owners. The good part of PMI is that it generates revenues around the world, and therefore is not dependent on the actions of any particular government.
The plain packaging in Australia was a blow to the tobacco industry. The risk is that other governments could follow suit. The problem with plain packaging is that it could essentially destroy brands. Strong brands grow dividends, because they are sought after by consumers, and provide companies with solid pricing power.