Is Philip Morris Stock About to Go Up in Smoke?

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Philip Morris (NYSE:PM) is a company that many are familiar with, but perhaps more so with its products. The stock is trading at $84 and still yields over 4 percent. However, there are some issues the company is facing, particularly a high debt load. But the stock could still be a buy going forward on a market pullback. For those unfamiliar, the company manufactures and sells cigarettes and other tobacco products.

The company’s portfolio of brands has Marlboro, Merit, Parliament, Virginia Slims, L&M, Chesterfield, Bond Street, Lark, Muratti, Next, Philip Morris, and Red & White. It also owns various cigarette brands like Sampoerna, Dji Sam Soe, and U Mild in Indonesia. It owns Fortune, Champion, and Hope in the Philippines; Diana in Italy; Optima and Apollo-Soyuz in Russia; Morven Gold in Pakistan; Boston in Colombia; and Belmont, Canadian Classics, and Number 7 in Canada.

The company sells its products in approximately 180 countries in the European Union, Eastern Europe, the Middle East, Africa, Asia, Latin America, and Canada. But with all of the anti-tobacco advocates and public health authorities cracking down on its products and its advertising, can Philip Morris continue to grow?

Well, in its latest quarter, the company reported diluted earnings per share at $1.18, down by 10 cents, or 7.8 percent, versus $1.28 in the comparable 2013 quarter. Excluding unfavorable currency of 16 cents, reported diluted earnings per share were up by 6 cents, or 4.7 percent, versus $1.28 in 2013. Adjusted diluted earnings per share were $1.19, down by 10 cents, or 7.8 percent, versus $1.29 in 2013.

Excluding unfavorable currency of 16 cents, adjusted diluted earnings per share were up by 6 cents, or 4.7 percent, versus $1.29 in 2013. The company saw cigarette shipment volume of 196 billion units, which was down by 4.4 percent. It also reported net revenues, excluding excise taxes, of $6.9 billion, down by 8.8 percent. Excluding unfavorable currency, reported net revenues, excluding excise taxes, were down by 1.6 percent.Reported operating company income was $3 billion, down by 12.9 percent. It was definitely a quarter of contraction compared to the prior year’s quarter.

The company, looking ahead, has raised guidance despite its declining sales and currency issues. Philip Morris revised the 2014 full-year reported diluted earnings per share forecast to a range of $5.09 to $5.19, versus $5.26 in 2013. So it is still less than last year. But the reported diluted earnings per share are projected to increase by approximately 6 percent to 8 percent versus adjusted diluted earnings. That is strong.

But here’s the problem: Since the end of 2008, the company has spent $56 billion on buying back its own shares and paying shareholder dividends. However, it has only generated $43 billion of free cash flow. Thus, the company is taking on debt. The company’s ratio of debt to earnings is rising fast. To keep its credit rating superb, the company has to bring cash flow in line with expenditures. This means that the company will have to reduce the buybacks or reduce the dividends. When either of these happens, expect the stock to dive. After the run the stock has had, I think it is time to take some profits, and we can reevaluate if and when the stock pulls back 10 percent or so.

Disclosure: Christopher F. Davis holds no position in Philip Morris and has no intention of initiating a position in the next 72 hours. He has a sell rating on the stock and a $75 price target.

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