Many may view the tobacco industry an an abhorrent one, but the fact remains that Philip Morris International (NYSE:PM) — which split from Altria (NYSE:MO) five years ago — has been a great investment. Over the past three years, the stock has posted an average return just under 25%.
Still, PM is in a tough market, as it must deal with extensive global regulations, heavy taxes and inevitable bad PR — like countless anti-smoking commercials. So, is the stock still a buy? To find out, let’s take a look at the pros and cons:
Brands. PM has a strong lock on the premium market, with marquee brands like Marlboro and Parliament. As a result — and perhaps because smoking is addictive — the company has shown tremendous pricing power over the years. Last year, price increases led to about $1.8 billion in additional income for the company. Plus, its global market share is 29% excluding the China and the U.S., and 15% overall.
Emerging Market. This is really the sweet spot for growth. As populations across the globe get wealthier, they tend to upgrade to premium brands; this has been the case in countries like Brazil and Russia. Plus, there are still many other countries with untapped potential. One is Vietnam, which has highly favorable demographics and has also been showing rapid urbanization and growth in purchasing power. PM is seeing similar trends in other countries like India and Malaysia.
Shareholder Focus. Since 2008, PM has increased its dividend by about 85%, making for a current yield of 3.7%. Since 2008, the company has returned about $50 billion to shareholders through repurchases and dividends. In fact, the company has bought back a whopping 23% of its outstanding shares during this period. And last August, the company instituted a new three-year $18 billion buyback program.
Regulations. For the most part, PM has done a good job with dealing with the onerous restrictions on smoking thus far. But going forward, the company will continue to have many challenges. One is a trend to mandate plain packaging, which has already been introduced in Australia. This will obviously make it tougher to market existing products — and to launch new ones. The European Union is also in the process of putting together comprehensive regulations which will ban methanol and slim cigarettes. Plus, there is talk of having 75% of packages showing graphic health warnings. Any of these moves could potentially have a negative impact on growth.
Taxes. Yes, governments continue to raise substantial revenue from excise taxes on cigarette sales. So far, PM has been able to deal with this through its aggressive price increases … but there are limits. In some countries, such as the Philippines, there have been moves to significantly increase tax rates. As a result, there could be a move away from premium brands, which will simply become too expensive. This could be especially the case in emerging markets, where incomes are still relatively low.
Europe. It’s a big part of PM’s business. Unfortunately, southern Europe is still in the midst of a brutal downturn. This has also been a drag on stronger economies like Germany. As a result, customers in southern Europe have been down-trading to cheaper brands or they have even resorted to the black market. While PM should benefit once the economy recovers, it looks like that could take quite a while.
All in all, Philip Morris definitely faces major headwinds. It will have to continue to fight back onerous regulations and find ways to keep down excise taxes. Plus, Europe will remain a problem for some time.
But PM has a long history of success and knows how to manage through complex regulations. If anything, this has become a huge competitive advantage. Heck, it would be pretty tough — to say the least — for a startup to enter the cigarette business. Instead, the industry is really about the few main players already in the game, including Altria, Philip Morris, British American Tobacco (AMEX:BTI), Reynolds American (NYSE:RAI) and Lorillard (NYSE:LO).
Besides, Philip Morris has great brands that generate substantial free cash flows, which came to $8.4 billion in 2012. And the opportunities in emerging markets look very promising.
In light of all these factors, the pros outweigh the cons on the stock.
Tom Taulli runs the InvestorPlace blog IPO Playbook. He is also the author of “How to Create the Next Facebook” and “High-Profit IPO Strategies: Finding Breakout IPOs for Investors and Traders.”Follow him on Twitter at @ttaulli. As of this writing, he did not hold a position in any of the aforementioned securities.