Philip Morris: Lighting a Fire for Growth

Source from:  InvestorPlace.com 12/03/2014

The media is rife lately with stories about the rapid ascendancy and growing vogue of electronic cigarettes - indeed, this month the Oxford English Dictionary chose "vape" as its word of the year for 2014. E-cigarettes are battery-powered devices that heat liquid nicotine in a disposable cartridge, creating a vapor that's inhaled or in popular parlance vaped.

PhilipMorris185 Philip Morris (PM): Lighting a Fire for GrowthVaping is considered hip among the younger demographic coveted by consumer brand companies and has posed a dilemma for makers of conventional cigarettes.

However, cigarette manufacturing giant Philip Morris International Inc. (PM) has never been caught flat-footed and the company is making adroit moves to exploit the trend. Philip Morris was previously negative on e-cigarettes, but the company has changed its mind and now embraces the technology, which should benefit PM stock over the long haul.

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This year, Philip Morris and Altria Group Inc (MO), an international cigarette and table wine producer, reached a deal to sell electronic cigarettes. Philip Morris has exclusive rights to sell Altria's e-cigarettes outside the U.S., whereas Altria received exclusive rights in the U.S. to sell other tobacco products developed by Philip Morris.

Philip Morris jumped aboard the e-cigarette bandwagon after several emerging countries began implementing new restrictions on tobacco products. But PM's keen interest in e-cigarettes isn't just a logical response to a new competitive threat.

Philip Morris also views e-cigarettes as a potential source of new growth to offset falling cigarette sales in developed countries and new regulatory barriers to sales in emerging markets.

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Regulators in emerging markets previously had been lax with cigarettes, but that's changing. Smoking crackdowns in the Philippines and Russia are two notable and recent examples whereby government officials have stepped in with tough new restrictions to curb rampant smoking and the serious health problems it entails.

Given these headwinds, it wasn't surprising that Philip Morris management announced that it expects international cigarette industry volume this year to drop by 2%-3% overall, by 7%-8% in the European Union and by 9%-11% in Russia. However, the company also said that it would invest $100 million in products other than traditional cigarettes.

Philip Morris began selling e-cigarettes in the second half of 2014 using existing technology. The company also has developed an e-cigarette that heats tobacco instead of liquid and doesn't need batteries; it plans to unveil this "new and improved" e-cigarette in 2015.

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PM Stock: Surviving Headwinds; Enjoying Tailwinds
Philip Morris' third-quarter fiscal 2014 earnings per share (EPS) came in at $1.39, down 3.5% from the same quarter a year ago. However, third quarter EPS beat Wall Street's consensus by 4.5%. Excluding an unfavorable currency effect of 20 cents, EPS exceeded the year-ago figure by 10.4%.

Third quarter revenue came in at $7.9 billion, down 0.9% on a year-over-year basis but up 4% excluding the currency impact. The consensus expectation for revenue had been $7.7 billion. Considering analysts' fears that anti-smoking regulations would substantially hurt Philip Morris, the company posted a solid earnings report.

Philip Morris has a long reputation for management foresight. The company is now in the process of reinvigorating its corporate brand throughout the world to compensate for declining sales of its traditional cigarettes.

That said, emerging markets remain attractive over the long haul, as a rising middle class embraces Western brands such as Marlboro, which remains the largest selling brand of cigarettes in the world and a symbol (for better or worse) of America affluence.

Philip Morris enjoys major exposure to corners of the global economy that are still in expansion mode. Although emerging markets aren't immune from developed-world regulations and economic ups-and-downs, they still pose a comparatively looser regulatory environment, especially in terms of marketing and advertising.

The growing disposable income of their status-conscious consumers means that Philip Morris' ubiquitously recognized brands should continue to enjoy reliable (albeit modestly diminished) demand. Moreover, even during lean times, consumers are still willing to pay a premium for trusted brands, which helps boost margins for PM stock.

Roughly 70 percent of Philip Morris' sales derive from emerging markets; China is the most coveted market. China's state-owned China National Tobacco Corp. (CNTC) leads the world in cigarette sales, mostly because of its virtual monopoly in the Chinese market. However, Philip Morris comes in second, with a nearly 15 percent share of the global market.

To be sure, the Chinese government on Nov. 28 passed tough new smoking restrictions that are likely to put a dent in cigarette sales in the Middle Kingdom. But that doesn't change the fact that China is home to 300 million smokers, accounting for more than a quarter of total cigarettes consumed around the world.

The Chinese market is mostly closed to foreign cigarette makers, but not to Philip Morris, which has a 50/50 joint partnership with CNTC to produce and sell cigarettes there, representing a beachhead for Philip Morris in a vitally important market.

PM Stock: Bottom Line

In times of uncertainty, consumer staples stocks offer a safe haven from both market turmoil and economic malaise. PM stock fits this bill. With a 4.6% yield, a vast and entrenched global presence and an exciting new product in the form of e-cigarettes, Philip Morris stock should light a fire for growth. Enditem