In the currently expensive market, it’s difficult to find growth stocks that are also trading at an attractive value point. This basically means that investors who are looking for growth need to be prepared to pay up for it. In this article, I’m focused on Philip Morris International (PM), which seems to provide both growth and value, plus an attractive and growing dividend yield to boot. I evaluate what makes PMI an attractive investment at the current price; so let’s get started.
(Source: Company website)
A Look Into PMI
PMI is the largest tobacco company in the world by market capitalization, and has 46 manufacturing facilities globally. In addition, it also has 25 third-party manufacturers across 23 markets, and 38 third-party hand-rolling operators in Indonesia, the largest tobacco market outside of China. It owns and manufactures both the well-known Marlboro and IQOS heated tobacco brands.
The current pandemic has made for a challenging operating environment, as social restrictions in many countries have reduced tobacco consumption. This was reflected in PMI’s Q3 results, with revenue declining by 2.6% YoY (1.5% decline on an organic basis) and shipment volume declining by 7.6% YoY. These appear to be the primary contributing factors to the negative share price reaction, since the earnings release.
As seen below, the market did not take kindly to PMI’s Q3 results. Since Oct 19th at the open, PMI’s shares have fallen by 6.6%, and as seen below, the shares are now trading at the bottom of their 3-month range.
While PMI does have near-term challenges, I see the market reaction as being largely unwarranted. That’s because volume declines were already previously communicated by management, and the third-quarter YoY volume decline was better than expected, and the volumes improved on a sequential basis. In addition, management now expects full-year 2020 volume decline to be 11%, which compares favorably to the 15% decline that was previously communicated.
In the meantime, I see PMI’s pivot towards RRPs (reduced risk products) continuing to pay off, as heated tobacco united shipment volume grew by 18.7% YoY in Q3, and 28% on a YTD basis. This, combined with strong pricing in combustibles, contributed to a 260 bps increase in adjusted operating income margin, and a 21% YoY increase in EPS.
Looking forward, I expect IQOS to be a more substantial growth driver for the company. This is supported by the fact that there are now 16.4M IQOS users globally. I dug into IQOS’ historical trends, and found that in Q3’19, there were 12.3M IQOS users worldwide. This represents an impressive 33% YoY increase in the number of IQOS users. RRPs (reduced risk products), including IQOS, now represent close to a quarter of PMI’s total revenues.
I’m also encouraged by the recent launch of IQOS VEEV, which is PMI’s new vapor product. As management noted, PMI is able to leverage the existing IQOS commercial infrastructure to deploy this product both efficiently and at scale. IQOS VEEV was first launched in New Zealand in Q3, and PMI is planning to roll this out to additional markets in Q4 and 2021.
I’m long-term bullish on the prospects for IQOS in the U.S., through its revenue sharing agreement with Altria (MO). One of the positive signs for its success has been the MRTP (modified risk tobacco product) designation that the FDA has assigned to IQOS, which could aid smokers’ decision to convert from combustibles to heated tobacco.
Based on Altria’s last conference call, its management appears to be positioning IQOS for success in America. Since its initial introduction in Atlanta, IQOS has been launched in its third lead market in Charlotte, North Carolina. Over the next 18 months, Altria plans to launch IQOS in four new markets with large adult smoker populations. I see IQOS as gaining traction in converting smokers through the MRTP designation and an eventual pickup in consumer mobility.
Through it all, PMI’s management has raised 2020 guidance to 5.5% YoY EPS growth at the midpoint, which is above the previous 4.75% growth guidance at the midpoint. Lastly, I find PMI’s 6.5% dividend yield to be attractive, especially in the current low-yield environment. Plus, management had enough confidence in the business to raise the dividend by 2.6%, starting with the October dividend payment.
The market appears to have given PMI’s shares a knee-jerk reaction in response to Q3 results, and I see this reaction as being a good buying opportunity. Volumes are understandably challenged in the current operating environment, and the decline was less than expected. IQOS continues to gain strong traction, with a 33% YoY growth in the number of users, and RRPs now represent nearly a quarter of PMI’s revenues. This, combined with strong pricing on combustibles, contributed to an increase in the adjusted operating margin, and management has increased its EPS guidance for the full year.
At the current price of $73.82, and a blended P/E of 14.4, the shares are trading well below their normal P/E of 17.0. For this, and the reasons stated above, I consider the shares to be a Buy. PMI currently offers an attractive combination of value, EPS growth and dividend growth.
(Source: F.A.S.T. Graphs)
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Disclosure: I am/we are long PM,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: This article is for informational purposes and does not constitute as financial advice. Readers are encouraged and expected to perform due diligence and draw their own conclusions prior to making any investment decisions.