Long-time Sure Dividend favorite Philip Morris shares jumped 8.7% yesterday. Philip Morris ranked #2 this April using The 8 Rules of Dividend Investing. The company recently released its 1st quarter 2015 earnings – the results were very positive.
Before we get into the results, here’s a quick fundamental rundown of Philip Morris:
- Dividend Yield: 4.7%
- Price-To-Earnings Ratio: 17.0
- 5 Year Dividend Growth Rate: 12.0% per year
Philip Morris is a rare combination of a high yielding stocks with a reasonable price-to-earnings ratio and a solid growth rate. The company has arguably maintained a reasonable price-to-earnings ratio because it operates in the slowly declining cigarette industry which has caused investors to miss the company’s stellar performance over the last several years.
First Quarter 2015 Results
Constant currency adjusted-earnings-per-share jumped 23.5% for Philip Morris. Earnings-per-share increases of 20%+ are results one would expect from a fast-growing tech stock, not a stable cigarette manufacturer.
Philip Morris’ cigarette shipment volume increased 1.4% versus the same quarter a year ago. Global cigarette volume is still growing around 1% a year. Cigarette volume growth is occurring in developing markets, with developed markets seeing slow declines in cigarette volume.
Volume increased 1.4% in the first quarter for Philip Morris. Constant-currency revenue (after excise taxes) grew 9.1% versus the same quarter a year ago. Revenue growth was strongest in the company’s Eastern-Europe/Middle-East/Africa segment (hereafter referred to as EEMA) and the company’s Latin America & Canada segment (hereafter referred to as LAC). Constant-currency EEMA revenue grew 13.9% versus the same quarter a year ago. Constant-currency LAC revenue grew even faster, up 14.2% versus the same quarter a year ago.
Constant-currency adjusted operating income grew 16.3% for Philip Morris versus the same quarter a year ago. Growth came largely from strong gains in operating margin. Operating margin growth by segment is shown below:
- European Union: Up 2.4 percentage points from 48.6% to 51.0%
- EEMA: Up 4.2 percentage points from 46.1% to 50.3%
- Asia: Up 1.4 percentage points from 43% to 44.4%
- LAC: Up 5.3 percentage points from 28.3% to 33.6%
The company’s operating margin increased in all of its segments thanks to efficiency gains and higher cigarette prices versus the same quarter a year ago. Philip Morris operating margin benefited from higher volume growth in its two most profitable segments (European Union and EEMA) than other segments. The company also benefitted from a slight shift toward premium cigarette brands.
Philip Morris & Currency Effects
Philip Morris sells cigarettes exclusively outside the United States, but it reports its results in U.S. dollars and pays its dividend in U.S. dollars. The U.S. dollar has gained about 20% versus a basket of worldwide currencies over the last year. This causes Philip Morris earnings to be reduced by about 20% when it reports them. This article focuses on the company’s constant-currency earnings because that shows true underlying business growth. Had the U.S. dollar fallen by 20% over the last year, it would be improper to say that Philip Morris’ underlying business grew by 20% – the same is true when the dollar rises.
Philip Morris stock had been facing pressure because the company must repatriate earnings to pay its dividend. The company has a payout ratio of 80.2%. At first glance, this means that much of the company’s earnings must be repatriated to pay its dividend – which would cause the company to take a 20% hit due to the differences in currency values when it repatriated the money. There is a workaround, however.
Philip Morris’ debt is not denominated solely in U.S. dollars. The company will pay out around $6.2 billion in dividends this year to shareholders. The company has $8.2 billion in debt denominated in Euros. If Philip Morris were to convert its currency to Euros – which are down about 20% this year – and buy up its European debt while simultaneously issuing debt denominated in US dollars, it could completely get around the issue of having to repatriate money to the U.S.
Philip Morris & Excellent Management
“We remain focused on managing our cash flow prudently and are steadfast in our aim to return around 100% of our free cash flow to our shareholders (emphasis added).”
- Philip Morris CEO Andre Calantzopoulos
Returning around 100% of free cash flow to shareholders shows how committed Philip Morris’ management is to total shareholder returns. The company is excellent t capital allocation. An example is below:
Philip Morris’ has maintained a dividend yield well above 4% since breaking off from Altria. The company has issued debt with interest payments well below 4% – some as low as 0.75%. The company used the proceeds of this debt to repurchase shares. This reduced the company’s cash flow obligations as the debt issued has a lower interest rate than the company’s dividend yield (yes – Philip Morris is not contractually obligated to pay dividends, but it is clearly committed to doing so). Reducing share count boosts the value of each remaining share. Philip Morris found a way to boost the value of each share while reducing future cash flow obligations with ultra low debt.
This year, the company has announced it does not plan to repurchase any shares. This is due to the strong U.S. dollar and the repatriation issue discussed above. If the dollar deprecates versus other currencies, I believe it is very likely that Philip Morris will resume share repurchases.
2015 Outlook
Philip Morris increased its 2015 earnings-per-share growth outlook from between 8% and 10% to between 9% and 11% for fiscal 2015. The increased earnings forecast includes higher spending on the company’s iQOS heated cigarette products which will launch in Italy and Japan towards the second half of 2015.
If the iQOS launch goes well, Philip Morris stock could see further solid gains in 2015. The aim of heated cigarettes is to provide full nicotine delivery and the smoking ‘feel’ without actually burning tobacco. Nicotine vaporizes at a lower temperature than tobacco burns, which is how this technology works. The iQOS heated cigarettes are billed as ‘less harmful’ than traditional cigarettes.
