Philip Morris: Put That in Your Pipe and Smoke It

Source: Thinkstock

Source: Thinkstock

Philip Morris (NYSE:PM) is a company that many are familiar with, but perhaps more so with its products. The stock has steadily risen over the years and yields over 4 percent. Recall that the company manufactures and sells cigarettes and other tobacco products. The company’s portfolio of brands include Marlboro, Merit, Parliament, Virginia Slims, L&M, Chesterfield, Bond Street, Lark, Muratti, Next, Philip Morris, and Red & White. It also owns various cigarette brands, such as 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, as well as 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. I recently wrote an article where I questioned whether Philip Morris stock was about to go up in smoke. The purpose of this article is to follow-up on that piece where I suggested the stock could be a buy on weakness if the company could deliver some surprise beats.

Well, Philip Morris crushed earnings, beating on the top and bottom lines. The company saw diluted earnings per share of $1.17, down by $0.13 or 10.0 percent versus $1.30 in 2013 but if we exclude unfavorable currency of $0.15, reported diluted earnings per share were actually up by $0.02 or 1.5 percent versus $1.30 in 2013. Adjusted diluted earnings per share of $1.41, up by $0.11 or 8.5 percent versus $1.30 in 2013. Further, these earnings beat consensus estimates by $0.17! if we exclude unfavorable currency of $0.15, adjusted diluted earnings per share were up by $0.26 or 20.0 percent versus $1.30 in 2013.

It was not all good news as expected. However, cigarette shipment volume was 222.8 billion units, down by 2.7 percent compared to last year. Reported net revenues, excluding excise taxes, were $7.8 billion, down by 1.5 percent from last year but beat analyst estimates by $280 million. The company saw all of its operating companies income come in at $3.0 billion, down by 13.1 percent from last year. Reported operating income was $2.9 billion, down by 13.9 percent from last year, but the company continues to increase shareholder value. How? Well, the company continues to pay its bountiful dividend and it even repurchased 11.6 million shares of the company’s common stock for $1.0 billion in the quarter. André Calantzopoulos, Chief Executive Officer, stated:

“As we expected, we achieved strong fundamental results in the second-quarter, driven by a lower volume decline, strong pricing, and robust market share. For the second half of this year, we anticipate more challenging quarterly comparisons, particularly in the fourth-quarter — which, in 2013, saw currency-neutral adjusted diluted earnings per share grow by 19.4 percent — due to known business challenges, particularly in Asia, the timing of investments behind the commercialization of our Reduced-Risk Products and the roll-out of Marlboro Red 2.0, as well as costs related to our manufacturing footprint optimization initiatives.

We are today reaffirming our 2014 full-year reported diluted earnings per share guidance. As previously communicated, down-trading and heavy price discounting at the low end of the market in Australia, in combination with the impact of plain packaging, could place us at the lower end of our guidance for currency-neutral adjusted diluted earnings per share growth of 6 percent – 8 percent for the full year.”

So the company has reaffirmed its 2014 full-year reported diluted earnings per share forecast to be in a range of $4.87 to $4.97 versus $5.26 in 2013. On an adjusted basis, as described below, diluted earnings per share are projected to increase in the range of 6 percent to 8 percent versus adjusted diluted earnings per share of $5.40 in 2013. Despite the declining sales and currency issues, the company is doing all it can to maintain earnings growth. The reported diluted earnings per share are projected to increase by approximately 6 percent to 8 percent versus adjusted diluted earnings. That is strong. However, there is still one major issue that I cannot look past.

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 $43bn of free cash flow. Thus, the company is taking on debt. The company’s ratio of debt to earnings is still rising fast. Eventually, 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 reiterate that I think it is time to take some profits and we can reevaluate if and when the stock pulls back into the mid-$70 range.

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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