The question of the day here on Invest Like Dad is: will Philip Morris stock recover or burn up in smoke.
Usually, I try to invest in companies that I believe in, and well, Phillip Morris (PM) may just be the exception. I do not agree with smoking from a health perspective, but the business is worth a look.
An investment in a cigarette company has some real risks as tobacco is addictive, and the single most significant cause of preventable death globally. This makes the company highly controversial, not even considering PM’s history of contradicting scientific evidence around the health impacts of smoking. Philip Morris has been and will continue to be the subject of litigation and restrictive legislation from governments.
Philip Morris International History
The history of Phillip Morris can be traced back to 1847 when Philip Morris himself sold tobacco and cigarettes in London. His son Leopard Morris established the company in 1881 that was later renamed in 1885 to Philip Morris & Co Ltd.
William Curtis Thomson gained control of the company in 1894, and in 1902 incorporated it in New York. Then in 1919, the business was acquired and incorporated as “Philip Morris & Co. Ltd., Inc.” in Virginia.
Philip Morris began expanding outside of the US in 1954 with its first affiliate in Australia. The expansions paved the way for setting up Marlboro, which quickly became the world’s top-selling cigarette brand.
The significant change happened in 2001 when the company transferred its operations center from New York to Switzerland. Then two years later, it renamed the company to Altria Group. Next, in 2008, Philip Morris International was spun off from the Altria Group.
The spin-off occurred due to lawsuits in the US as well as the ability to have Philip Morris focus on the international markets while Altria Group focused on the US market.
Philip Morris Financials
An interesting thing about Philip Morris is that everything they do is affected by prevailing exchange rates as they operate in 180 countries.
Liquidity & Balance Sheet
PM has $3.7 billion in cash as well as $7.5 billion available in revolving credit facilities. Additionally, Phillip Morris’ debt is laddered well with only $300 million worth of bonds maturing in 2020. From a short term perspective, the company can pay its bills.
It did pay off $3.6 billion in bond maturities in Q1 2020, which is good to see. But the large dividend hits the balance sheet pretty hard coming in at $3.6 billion already paid out to shareholders by April 2020. This limits the company’s ability to pay down debt.
Due to some slowdown in 2020, the company has reduced its capital expenditures by $200 million and is still on track to a multiyear plan to provide $1 billion in efficiencies by 2021.
Talking about debt, PM has a ton of it totaling almost $25 billion. With low-interest rates and a focus on reducing debt, the company seems to be getting on track with its debt. They did have its debt peak above $31 billion in 2017. Considering where they were, the 25 billion is not as bad. With that said, it still has a ton of long term debt.
PM has a dominant position in the cigarette market around the world. As you can see in the chart below, PM has the top 6 brands in the world.
As I mentioned before, there are significant headwinds for cigarettes nowadays, but the industry is shifting towards heated tobacco units (HTU) as the answer.
As you can see from the chart from PM below, Q1 2020 is down, but some of that is from COVID-19. The dark blue is HTU, which is showing an increase from 2019, and it now makes up 10% of worldwide sales.
HTU are considered “safer” than traditional cigarettes, and they are similar to e-cigarettes in the US.
HTU were introduced in 2015 and have shown real growth in the past 5 years.
Countries with Notable Differences
Indonesia – cigarette industry volume down .6% and increased competition with mid and low-priced brands that have resulted in PM Cigarette share dropping 2.3% in Indonesia.
Europe – has seen 1.8% growth compared to last year in HTU sales.
Russia – a huge growth market that has seen HTU grow by 3.5% compared to last year.
Japan – Has seen HTU grow from 15.2% in Q4 2018 to 19.1% in Q1 2020.
As you may have noticed HTU is the growth opportunity with PM an PM is shifting its resource to provide that smoke free future.
Copy Cat Lawsuit for Philip Morris
In April of 2020, British American Tobacco filed a patent infringement lawsuit against Philip Morris in the US, UK, & Germany over technology used in IQOS tobacco products, which are HTU by sales classifications.
British American Tobacco has said, “If we win, we may be able to get an International Trade Commission exclusion order blocking the importation of IQOS into the U.S. by Philip Morris unless they agree to take a license to our patents.” (US News Article with more info can be found here)
Marketing Legal Action for Philip Morris
The big tobacco companies are challenging a new FDA ruling that went into effect in March 2020. This new FDA rule, “Required Warnings for Cigarette Packages and Advertisements,” establishes 11 new cigarette health warnings. These new warnings consist of statements as well as photorealistic images that depict the negative health consequences of smoking. These new required warnings illustrate some of the lesser-known, but severe health risks of smoking.
These new advertisements are not great for business, and R.J. Reynolds has led the charge, but now PM has joined the fight by filing a second challenge in Federal Court.
Philip Morris’ lawsuit looks very similar to another industry lawsuit back in 2011 to the previous version of the graphic warning rules. PM alleges that the graphic warning label rule from the FDA violates the First Amendment for multiple reasons:
- The labeling requirements place a burden on manufacturers by forcing them to display anti-smoking messages over 50% of cigarette packaging and 20% of advertising, thus drowning out their own words about their product.
- The FDA failed to meet the strict standards required for compelled speech. The lawsuit states that the FDA’s marginal interest in more effectively educating consumers about less-known health risks of smoking is insufficient to justify a ruling that forces manufacturers to carry messages aimed at pushing away their customers.
- The lawsuit also claims that the warnings are misleading in that they misrepresent the relative risks of smoking-related health consequences.
- Lastly, the industry argues that the new labeling requirements violate the First Amendment by forcing manufacturers to seek pre-approval of their labeling and advertising plans.
Excluding the US & China, Philip Morris controls 28% of all tobacco sales in the world. It is the largest publicly traded tobacco company. Its development and implementation of the iQOS have great potential, and if allowed in the US will provide a significant boost to sales. PM commands a lot of loyalty in the highest price segments and is positioned well to benefit from that loyalty!
So what are the downsides, well the first is regulations. PM has a vast moat, but that moat is continuously under threat of new regulations. Another risk is the strength of the dollar. As the dollar increases, it creates a negative impact on earnings. The final risk is the HTU market that is the wild west as tax, and regulatory laws have not caught up to the consumer market.
With all that said, I think Philip Morris is worth consideration at $70 with a fair market value that I calculate to be around $100. Currently, it has a dividend yield of over 6%. The payout ratio is high at 97%, and the company is working on paying down debt.
Additionally, PM is transitioning its product offering to smoke-free products, so there may be some near-term pain & risk. Still, the plan presented by management has to PM will less debt and fully transitioned over the next five years.
This post is my opinion, which is strictly for information & educational purposes only. The post is not intended to provide any investment advice. Please seek your own duly licensed professional for investment advice as they will be able to consider your situation. Please read my Terms & Conditions Page for a full disclaimer.