Tobacco companies, despite the many headwinds they face, continue to be popular with medium- to long-term investors looking for dividends.
An increasingly health-conscious public, mounting regulatory pressures and a fall in duty-free sales caused by the Covid pandemic are all factors that have forced tobacco companies to stay as efficient as possible, cutting costs wherever possible, looking for synergies through mergers with rivals and diversifying into the so-called Next Generation Products to meet the growing demand for less harmful forms of smoking.
Philip Morris International (NYSE:PM) opened trading on 12/11/20 at $74.61, representing a 4% increase over the week, though still well below its fair value of $128.54. The stock is 13.39% down year to date, but has been on an upward trend throughout the period and is now midway on its 52-week range. It has posted a one-year return of -10.2%, which compares favourably with the US tobacco sector’s -14.8%, though well below the US market’s 18.7%.
Philip Morris International: better than expected Q3
Philip Morris International had a better than expected third quarter. Net revenue was down only 2.6% to $7.45bn year-on-year, operating income edged up 1.9% to $3.24bn and the adjusted earnings per share for the quarter was $1.42, beating analyst forecasts of $1.36.
For the nine months to the end of September, pre-tax earnings were up 9.4% to $8.24bn. Analysts are forecasting growth of an average of 8.5% per year for the next three years, though again this is less than for the US market (21.5%). The current P/E ratio of 16.23 is disappointing from an investor’s point of view, when compared to its sector rivals. Costs were cut by 21% to $1.77bn and gross profit was flat at $5.03bn.
Per share dividend raised
The business has held with its policy of increased dividend payments for the past 10 years, and in September, it raised its per share dividend 2.6%, to $1.20, up from $1.17 in September 2019. Its dividend yield is currently 6.39%, below the sector average of 7.8%. Its dividend yield is the weakest among its sector rivals, such as Imperial Brands (14.83), Vector Group (9.45), Altria Group (8.86) and British American Tobacco (8.22).
One area of concern for investors is the high level of debt, which however is currently well covered by operating cash flow of 34.1%. Another area of note is that insiders have only sold shares in the past year.
Is there a future for big tobacco companies?
Analysts like to question the prospects of tobacco companies, since they are being stigmatised as ‘sin stocks’ and increasingly squeezed out of investment portfolios. Not surprising, then, that these companies have been looking for ways to transition away from cigarettes and make their strategy more sustainable.
Philip Morris International pinned its hopes on smoke-free products and, in collaboration with Altria Group (the renamed Philip Morris brand), last year launched IQOS, an electronic tobacco heating product. In July this year, the gamble paid off, when the US regulators approved the product as a ‘modified risk tobacco product’.
Philip Morris International inevitably hailed the regulator’s decision as an ‘historic public health milestone’, as questions about the product being safer than cigarettes remain. The decision may yet prove to be a pivotal point in their business strategy, given that IQOS products accounted for up to a quarter of the company’s third quarter revenue. Philip Morris International offered a positive outlook, saying it expects to post an adjusted EPS of between $5.05 and $5.10, a shade below last year’s $5.13. The upward trend looks likely to continue.