Philip Morris International Is A Strategic Pick Going Into 2016

Source from:  Seeking Alpha 12/23/2015

Philip Morris (NYSE:PM) is a tobacco company that sells 100% of its products outside of the United States. Over the past year or so the company has performed well despite intense currency headwinds due to the continued strength of the dollar, which only seems to be strengthening even more as we head into 2016. But the underlying business of PM is rock solid and is almost guaranteed to grow going forward, especially if we see a weakening of the dollar, which experts predict will more than likely happen sometime next year.

If you factor currency headwinds into PM's most recent earnings report, they posted a 6% increase in revenue and 17% increase in earnings per share. While it may not seem like this matters when currency headwinds are real and actually led to the company reporting a 12% YoY revenue decline, and 11% EPS decline, what it tells us is that the underlying business is performing very well. And while we cannot predict the future, the U.S. dollar simply cannot strengthen indefinitely. When it does start to shift and weaken relative to other currencies, it will be a huge boon for PM and the stock will take off. But before that happens, there is a lot to like about the stock despite these powerful currency headwinds.

PM pays one of the highest yields in the industry, with a current yield of 4.69%. The only tobacco company that pays a higher yield is Vector Group (NYSE:VGR), which currently yields over 6%. But PM is many times the size of VGR, has a lower payout ratio, and operates internationally, which should provide a lot more long term growth than any of the domestic tobacco companies. One of the reasons PM's stock has been doing as well as it has this year is due to strong earnings in market's like the EU and Asia. And while the currency issue mentioned above has held back their results, price increases that management has said they intend to make in 2016 should make up a lot of lost ground from the strong dollar. One of the greatest aspects of tobacco products is their amazing pricing power. There may not be another product on the planet that can raise prices on command as easily as tobacco companies because their customers are addicted. Warren Buffett once commented that he likes tobacco stocks because, "They cost a penny to make but sell for a dollar, are addictive, and have brand loyalty." The only reason he doesn't own them is because he believes it would hurt his reputation. That's a pretty big endorsement from arguably the greatest investor in history.

But PM has even more going for it than the other tobacco giants, which continue to outperform the market despite negative growth in the U.S. In fact, as unbelievable as it may be to some, tobacco continues to be America's most successful industry even outperforming the fast growing tech industry over time. The trump card PM holds that makes its business more attractive than the other great companies in the industry is that it operates in the much faster growing international market. And while that hasn't seemed to have helped it much in the past ten years since it split off from Altria (NYSE:MO), that is mostly due to bad luck. The dollar has basically gone on an unprecedented run over the last several years, which is highly unlikely to continue going forward as the Chinese Renminbi is rising and has become one of the world's official reserve currencies and the Fed continues to raise interest rates over the course of the next few years.

For investors with a long term perspective, PM provides both growth and stable cashflow, which are the factors that have outperformed the market through thick and thin and why dividend paying stocks tend to generally outperform their non-dividend paying counterparts when you factor in the reinvestment of the yield. This is subtle because it's much easier to see the growth numbers of high flying tech stocks in earnings reports than the combined long term performance of a "boring" consumer discretionary stock. Especially when a large part of the latter's success is based on defense during downturns and slow but stable cash flows. One thing we tend to miss is that high flying tech stocks like Amazon tend to have sharp down years during bear markets, which can erase a large portion of that stock's gains during the bull cycle. Tobacco stocks on the other hand tend to outperform on the way down, which makes a huge difference over long time periods as you can see from the article link above showing how the industry has outperformed every other industry in history.

Regarding PM's current valuation, the stock trades at only 18 times earnings, which is right around the average P/E of the S&P 500. But PM is a better than average company, which is one of the reasons I consider the current price to be a slight undervaluation. When you factor in the great yield, and stability going into a very uncertain year for the stock market, PM becomes very attractive at current levels. And while some continue to worry about forex issues and a relatively high dividend payout ratio of 90%, which is actually the normal payout ratio for real estate investment trusts (REITs), tobacco companies have the most stable cash flow of any product on the planet and the company is actually posting growth despite strong currency headwinds.

Overall, PM is one of the safest stocks you can hold if your time horizon is long. Warren Buffet has repeatedly said that one of the keys to his astonishing success is that he looks at performance over 5 year time frames rather than one year or even shorter time frames. For companies like PM that pay a high yield, have huge potential growth in emerging markets, and super stable cashflow, your capital is all but guaranteed to be safe in this stock while it earns an adequate return. According to the legendary Benjamin Graham, this should be the goal of every true investor. Enditem