Published February 3rd, 2017 by Bob Ciura
Shares of tobacco giant Philip Morris International (PM) rose 3% on February 2, after the company posted a mixed earnings report.
Earnings-per-share missed expectations, but sales surpassed analyst estimates, for the fourth quarter.
Investors were relieved to see growth over the past year, as PM has been dragged down by the strong U.S. dollar and falling smoking rates in certain geographic markets.
Fortunately, the company is enjoying robust growth in new products. This could help secure PM’s dividend going forward.
PM is a hefty dividend payer—the stock has a current yield of 4.3%. Since its spin-off from Altria Group (MO) in 2008, PM has increased its dividend by 126%.
If the company can continue to raise its dividend, PM will soon become a Dividend Achiever, a group of 272 stocks with 10+ years of consecutive dividend increases.
You can see the entire list of all 272 Dividend Achievers here.
While foreign exchange continues to dent PM’s overall results, the operating performance remains solid. This article will discuss PM’s recent results, and its future growth catalysts.
PM reported fourth-quarter earnings-per-share of $1.11 and revenue of $7 billion. Earnings-per-share fell short by a penny, but revenue came in well ahead of projections.
PM beat revenue expectations by roughly $400 million for the fourth quarter.
The revenue beat was a welcome sight for investors. In 2015, PM’s revenue fell 10% for the year.
This time around, while the strong U.S. dollar still wiped off $1.3 billion of revenue for the year, PM’s core operations performed much better.
Net revenue fell just 0.4% for the year. Revenue, excluding excise taxes, increased 4.4%. Adjusted earnings-per-share increased last year, which was the first annual increase since 2013.
Source: Fourth Quarter Earnings Presentation, page 8
And, revenue growth accelerated as the year drew to a close. Organic revenue, which excludes excise taxes, increased 9.1% in the fourth quarter.
This was a much higher revenue growth rate than tobacco companies typically generate, and speaks to the rapid success of PM’s new products.
Last quarter, revenue growth was driven by increased adoption of PM’s reduced-risk portfolio, including HeatSticks and iQOS.
Source: Fourth Quarter Earnings Presentation, page 6
PM’s reduced-risk products, in the e-vapor and e-cigarette categories, have already taken significant market share around the world.
Source: Fourth Quarter Earnings Presentation, page 20
PM shipped 7.4 billion units of HeatSticks last year. Shipments totaled just 396 million in 2015. This massive growth helped the company offset a 4.1% decline in cigarette shipment volumes in 2016.
This gives PM a valuable advantage. Consider that Altria’s revenue increased just 1.2% in 2016, in part because iQOS has not yet received FDA approval for U.S. distribution. This could be a benefit for PM moving forward, relative to its close peer Altria.
Another attractive aspect of PM’s business model is that it has exposure to several emerging markets in Europe and Asia.
For example, the company saw double-digit operating profit growth in Russia last year.
Source: Fourth Quarter Earnings Presentation, page 14
The reduced-risk portfolio is growing rapidly in Japan.
Source: Fourth Quarter Earnings Presentation, page 15
And, PM grew adjusted operating profit by 12.4% in Latin America and Canada, excluding currency.
In 2017, PM expects earnings-per-share to reach $4.70-$4.85, on a constant-currency basis. This would represent 9%-12% growth from last year.
New products should have a lot to do with this. PM has launched iQOS in 20 markets to-date, and expects to increase iQOS penetration to 30-35 markets by the end of 2017.
Competitive Advantages & Recession Performance
PM enjoys a number of competitive advantages. First is has a strong brand. It operates Marlboro outside the U.S., which is the leading cigarette brand.
Marlboro commands high market share across PM’s core European markets, and saw its position expand in several of them last year.
Source: Fourth Quarter Earnings Presentation, page 13
These competitive advantages make PM a recession-resistant business. For example, the company saw only a mild dip in earnings-per-share during the recession, and quickly recovered after it was over:
- 2008 earnings-per-share of $3.32
- 2009 earnings-per-share of $3.24
- 2010 earnings-per-share of $3.92
The tobacco industry has very favorable economics. With low capital investment requirements and pricing power, PM generates billions of cash flow each year.
In 2016, PM’s free cash flow increased 4.9% in constant currency.
This provides PM the ability to navigate difficult environments like this. Currency reduced free cash flow by $340 million in 2016.
Plus, the company incurred higher capital expenditures, to expand manufacturing capacity of HeatSticks.
Even so, PM still generated $6.9 billion of free cash flow for the year.
PM’s high free cash flow allows the company to return a great deal of cash to shareholders each year.
The company’s annual dividend payout totals $4.16 per share. In 2016, PM’s earnings-per-share grew 1.4%, to $4.48.
PM is an appealing dividend stock because it offers a high yield of 4.3%. The downside is that the company maintains a high payout ratio, of 93%. This is very tight, as the dividend amounts to nearly all the company’s profits.
As a result, PM’s dividend growth slowed down last year. It managed just a 2% dividend hike in 2016.
Fortunately, there is hope that PM will return to higher dividend growth rates in 2017 and beyond, as the company’s earnings growth rate is expected to accelerate.
And, the current dividend should be sustainable, as long as earnings do not decline from 2016 levels. PM suspended share buybacks in 2016, which helped free up more cash for the dividend.
PM has faced a number of challenges over the past few years. The strong U.S. dollar and falling smoking rates weighed on the company’s earnings and dividend growth in 2016.
Going forward, new products such as HeatSticks and iQOS stand a good chance of returning the company to higher growth rates. This would be a huge positive for future dividend growth as well.
PM’s strong brand and 4.3% dividend yield make the stock an attractive choice for income investors.