Philip Morris International (NYSE: PM) is an American multinational tobacco company that was spun off from Altria (NYSE: MO) to focus on tobacco sales outside of the United States. Following the spinoff, Philip Morris International has established and maintained solid cigarette market shares across the globe. However, Philip Morris International has encountered challenges growing their financial metrics over the last decade due to declining cigarette volumes and various government interventions to reduce tobacco usage, including through the use of high excise taxes. These challenges have prompted the company to develop and become a leader in reduced risk tobacco products to help create a sustainable and long-term source of revenue for the company. Interestingly, Altria (NYSE:MO) faces similar cigarette volume declines as Philip Morris International, though Altria has experienced steady growth over the last decade, has significantly less excise tax than Philip Morris International and has focused on expanding into oral tobacco products and non-tobacco products, though some of these acquisitions have come at significant cost to the company. While Altria is arguably at a more appealing valuation, I believe that Philip Morris International’s diversification and focus on innovative reduced risk products could make them an appealing dividend investment.
The Core Business
Philip Morris International is a multinational tobacco company that sells products in over 180 countries. The company was spun off from its parent company Altria in 2008 to allow Philip Morris International to pursue more sales growth in emerging markets and to have more freedom operating outside of United States including from potential litigations and legislative restrictions. Over the last decade following the split, Philip Morris International has seen slow to no growth in key financial metrics, with revenue and gross profit increasing annually on average by about 1% on a compounded basis and net income slightly decreasing during this time period. However, the company’s long-term debt has steadily increased by nearly 8% on a compounded basis over the last decade. On first glance, it appears that they have struggled to achieve significant growth in the last decade following their split from Altria.
Source: Created by author using data from Seeking Alpha Financials.
In order to understand if Philip Morris International’s dividend is sustainable and some of the company’s plans to promote growth, let’s take a look at their key business segments. As of the end of 2019, their main business areas included:
- Combustible products: Philip Morris International predominantly sells American blend cigarettes internationally, including Marlboro, Philip Morris, L&M, Parliament, Bond Street, Sampoerna A, Virginia Slims, Champion and Chesterfield.
- Reduced Risk Products (RRP): Philip Morris International predominantly sells Platform 1 devices (heated tobacco units) under the IQOS brand and are marketed as reduced risk compared to traditional cigarettes.
According to Philip Morris International’s Q3 earnings call, the company is expected to have at least 8% adjusted diluted EPS growth through 2021 and analysts predict that revenue will grow by about 6% through 2022. A significant part of this growth will be fueled from the sales of the company’s RRPs. Below, we can see that their RRP net revenue (after excise tax) has seen strong sales growth, with net revenue increasing by over $6 billion for RRP sales over the last five years.
Sales of combustible products still make up the majority of Philip Morris International’s total revenue, though cigarette sales have been steadily declining. Smoking is currently the leading cause of preventable death globally, which has resulted in governments and agencies, including the world health organization, taking a number of steps to reduce cigarette use. According to the world health organization, about 2% of smokers are expected to quit over the next five years, which is also in line with long-term smoking rate studies. Philip Morris International’s cigarette sales have indeed decreased over the last five years, with volumes decreasing by nearly 4% annually on a compounded basis. This is similar to Altria’s declining cigarette volumes, with the company having 4.3% declines annually on a compounding basis over the last five years. However, despite the declining cigarette volumes, both companies have maintained steady shares of their respective markets from 2010 to 2019. Taken together, this highlights how combustible sales are stable, though the secular decline of cigarettes has encouraged Philip Morris International to expand their sales to include more sustainable tobacco products.
One of Philip Morris International’s strategies is to transition away from cigarettes to more sustainable and modified risk products. As mentioned above, the world health organization strongly encourages countries to take steps to reduce cigarette use, including imposing excise taxes on cigarette sales. Indeed, there is significant excise tax on tobacco sales from Philip Morris International, with excise taxes peaking at nearly 65% of total revenue in 2016. In fact, from 2010 to 2015, excise tax increased by over 3% annually on a compounded basis. Starting in 2017, Philip Morris International started having revenue growth exceeding the excise tax increases, which corresponds to the significant increase in the company’s RRP sales.
Source: Created by author from PM 10-K filings.
Interestingly, Altria also faces excise taxes, though the degree of these taxes has been much more moderate. The highest excise tax Altria reported was a little over 30% of their total revenue in 2010, and has steadily declined over the last decade. Part of this recent decline has also been driven by sales of Altria’s noncombustible products, which have significantly less excise tax than their traditional cigarettes. This highlights just how important it is for tobacco companies, especially Philip Morris International, to transition away from traditional cigarettes to more sustainable and tax efficient products.
Source: Created by author from MO 10-K filings.
Transition to Reduced Risk Products
Philip Morris International’s primary strategy to transition into reduced risk products involves reducing the exposure of toxic substances inhaled through traditional combustible cigarettes. This strategy revolves around the sales of four different platforms as shown below:
- Platform 1: IQOS heat control technology that creates an aerosol through heating instead of combustion. Clinical studies have shown that IQOS can reduce harmful and potentially harmful constituents (HPHC) by up to 95%, has FDA approval as a mitigated risk tobacco product and is licensed to Altria for sales in United States.
- Platform 2: Utilizes a carbon heat source to generate a nicotine-containing aerosol. The reduced exposure clinical study found a significant reduction in biomarkers associated with exposure to HPCHs.
- Platform 3: Designed to provide an aerosol of nicotine salt.
- Platform 4: Includes e-vapor products including IQOS MESH products. Animal studies found reduced biological responses associated with cardiovascular and pulmonary diseases compared with traditional cigarette smoke.
Currently, Philip Morris International’s platform 1 and IQOS products make up the majority of their RRP product sales, with IQOS being one of the leading RRPs in the industry. Currently, there are over 15 million IQOS users with the global health crisis actually increasing the transition of smokers to IQOS products. These next generation tobacco products have seen significant growth over the last few years, are scientifically supported to reduce exposure to harmful chemicals compared to traditional cigarettes, offer potential growth opportunities and could provide more sustainable sources of revenue for the company.
This is in contrast to Altria, which has taken a strategy of providing reduced risk tobacco products and other non-tobacco sin stocks. I discussed this more in a previous article, but essentially Altria has been focusing on potentially reduced risk tobacco products including oral tobacco (Altria’s leading product Copenhagen is currently in review by the FDA as a modified risk tobacco product), electronic cigarettes especially via their JUUL acquisition, alcoholic beverages and cannabis. Although Altria’s strategy is diversified outside of tobacco, their acquisitions have significantly increased the company’s debt and have resulted in non-cash impairment charges.
Other Potential Challenges
The main challenge to Philip Morris International is the secular declines of their core combustible sales. As discussed above, organizations and governments have taken steps to reduce tobacco consumption. Philip Morris International predicts that, at the current rate of cigarette decline, the number of smokers over the next decade will remain largely unchanged. This has helped result in aggressive initiatives by governments and agencies to reduce tobacco use including via increasing excise tax, smoke-free laws, pictorial health warnings, anti-smoking adds (sponsored by tobacco companies) and reducing the amount of nicotine in cigarettes. I believe the ability of Philip Morris International to provide less harmful and more sustainable products will be essential to help address the health problems associated with smoking and the long-term success of the company.
In addition to the secular declines in the smoking rates, Philip Morris International also faces challenges from the current global healthcare crisis. In particular, Philip Morris International’s duty-free business, which allows for the exemption of local or national taxes for travelers taking the goods out of the country, has been severely hit by travel restrictions. Furthermore, restrictions and declines in general income from the global healthcare crisis has also resulted in accelerated declines in cigarette volumes in various regions, including Indonesia, Mexico and the Philippines. However, Philip Morris International has also managed to reduce manufacturing disruptions due to the global healthcare crisis and the company does not anticipate running out of products.
It is also important to note that Philip Morris International faces challenges from illicit tobacco trade, which can be exacerbated in particular regions by higher than average excise taxes.
Valuation & Dividend Analysis
The table below shows some of the key valuation metrics between Philip Morris International and Altria as of Friday October 23rd. Below, we can see that Philip Morris International is at an appealing forward adjusted PE Ratio and dividend yield compared to the historical average over the last decade and has a reasonable forward PEG ratio. Where Philip Morris International really shines is with their very high ROC (Joel Greenblatt) metrics, indicating the high quality and efficiency of the company. This is in comparison to Altria, which has an even more appealing PE ratio, dividend yield and PEG ratio, but also has a higher debt to market capitalization ratio and lower, albeit still impressive, ROC. It is also important to note that the free cash flow payout ratio for Philip Morris International typically covers the dividend, though recently this ratio significantly increased due to recent challenges associated with the global healthcare crisis discussed above.
|Forward Adjusted PE Ratio||14.54||9.04|
|10 Year Average Adjusted PE Ratio||17.08||15.25|
|10 Year Average Dividend Yield||4.68%||5.05%|
|Total Debt/Market Cap||0.25||0.4|
|FCF Payout Ratio (6 months ended)||134.24%||64.59%|
|Forward PEG Ratio||2.12||1.89|
|ROC (Joel Greenblatt)||179.84%||125.75%|
Source: Created by author using data from Seeking Alpha and Gurufocus.
There is a great deal to like about Philip Morris International. Philip Morris International has focused on developing a diversified portfolio of products and geographical sales and is a leader in RRPs including IQOS that could serve as a sustainable long term source of revenue for the company. These advantages with Philip Morris International have the potential to lead to increases in revenue and EPS for the company over the next few years and is reflected in Philip Morris International’s impressive ROC (Joel Greenblatt). This is in comparison with Altria, which had steady growth of financial metrics over the last decade and is at a more appealing valuation. However, Philip Morris International had not recorded a charge to earnings for an impairment of goodwill as of the end of 2019, whereas Altria recorded billions in impairment charges and a significant increase in their debt ratio due to their acquisitions including JUUL.
It is important to note that while both companies face challenges with future government regulations, Philip Morris International faces significantly higher excise taxes that accounts for about 60% of the company’s total revenue. Furthermore, Philip Morris International also faces challenges from illicit tobacco products which can be exacerbated by higher excise taxes. Finally, future changes enacted by the FDA, including limiting the amount of nicotine in tobacco products, could also influence the regulatory approach of other governments.
Below I summarize what aspects of the company I’m personally optimistic and pessimistic about. I believe that Philip Morris International is a better choice in regards to the safety of the business, while Altria offers a better valuation. I personally lean towards Altria due to their appealing valuation, though I believe that both companies offer a potentially rewarding dividend investment and I am seriously considering purchasing Philip Morris International going forward.
Source: Created by author.
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Disclosure: I am/we are long MO. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: I am not a financial advisor and this is not financial advice. Not all relevant risks are covered in this article. Investors should contact a licensed financial advisor and do their own research before investing.