With more and more health concerns surrounding tobacco consumption around the world and about smoking in particular, any sort of support for tobacco companies can be controversial. But massive tobacco companies still exist (and will continue to do so for the foreseeable future, at the very least) and they are usually very lucrative for their investors. So, let us leave the ethical questions aside for the time and see if Philip Morris International Inc. (PM, Financial), despite its consistently high dividend payouts, makes for a good investment choice for those looking to buy in to the tobacco story.
A matter of habit
Tobacco consumption may be a bad habit, potentially deadly even, but it is still a habit and it is not about to go away any time soon. Insofar as that stands, tobacco companies selling well-entrenched brands, like Marlboro that Philip Morris does, make for a sensible investment choice within the larger consumer segment.
Business around the world
PM was spun out of Altria Group Inc. (MO, Financial) into a separate entity in March 2008 that would sell tobacco products internationally. In the course of doing that, it has run in to rough weather. Apart from having to compete with cheap local brands everywhere, it is subject to legal regulations in different jurisdictions, many of which are passing increasingly stringent laws to curb rates of smoking within their own countries. The company has taken the governments of Uruguay and Australia to court already and is planning to also sue the British government for its newly passed law that makes mandatory plain packaging for cigarettes and larger warnings on the packs.
This is quite different from the domestic U.S. market where a similar FDA requirement was overturned by the court in 2012, allowing tobacco companies to package their cigarettes the way they saw fit.
In recent months, the company has also been hit by a strengthening U.S. dollar, since it earns in a number of foreign currencies.
Company financials
Looking at the stock price of the company for the last five years and comparing it with other tobacco bigwigs like Altria or Reynolds American Inc. (RAI, Financial), we see that PM hasn’t performed all that well. Compared with around 150% growth for the other two, PM’s stock has climbed by less than 100% at its highest point two years ago.
However, the company has maintained a high dividend yield, consistently returning value to its shareholders. Its last dividend yield was above 5.2 percent. Despite a weakening bottom line, increasing debt and the risk of downward credit rating, the company maintains a serious commitment to not reduce dividends. According to CEO Andre Calantzopolous, “I don't see scenarios under which we will reduce our dividends, unless we have a third World War.”
As a result of contracting free cash flow and concerns over credit rating, the company has decided to suspend buyback of shares for 2015, which is quite unusual for a company that has averaged over $5.3 billion in buybacks over the last five years.
Smokeless products
In light of the increasing regulatory troubles and campaigns against smoking, other tobacco companies have been diversifying in to smokeless products such as electronic cigarettes, snuff and even alcohol. However, in the case of Philip Morris International, these products make for an insignificant amount of its revenues so far.
Conclusion
If you are the sort of investor who is looking for short term gains through dividend yields, you cannot go wrong with Philip Morris International, given its management’s commitment to dividends. If the company goes back to its aggressive share repurchase program next year, it will create even more value for investors. As a long-term story, however, we do not think PM is a good bet. For now, our recommendation for Philip Morris International is HOLD.
