Could Philip Morris International Inc. (PM) Stock Go Up in Smoke?

Philip Morris International Inc. (NYSE:PM) stock is up over 79% since being spun off from parent company Altria Group Inc (NYSE:MO). Investors have supported PM stock for years because of a generous dividend yield and strong sales of cigarettes around the world. The big question now could be whether the strong dividend will continue as Philip Morris pours billions of dollars into making alternatives to cigarettes and possibly getting away from its massive money maker.

PM Stock: Could Philip Morris International Inc. (PM) Stock Go Up in Smoke?Andre Calantzopoulos, chief executive officer of Philip Morris, surprised many by saying recently his company could one day stop making conventional cigarettes. Calantzopoulos may be talking about decades from now, but the fact is his company is quickly becoming serious about pushing their cigarette alternative products to consumers around the world.

Philip Morris has developed the iQOS, a reduced-risk product that heats up tobacco and provides a real taste but doesn’t use combustion. Philip Morris believes this makes the product less harmful than cigarettes, but this has not been proven yet.

Philip Morris has spent at least $3 billion to develop this category. Rival British American Tobacco Plc (ADR) (NYSEMKT:BTI) is also betting big on alternatives to cigarettes, but in the vapor category.

British American Tobacco believes vapor will be a bigger category, an area that has already seen people switching to from traditional cigarettes. The company is working on acquiring Reynolds American, Inc. (NYSE:RAI) which would make it the largest internationally tobacco company. Philip Morris would trail them and have some major competition in the alternative cigarette market. Both British American Tobacco and Reynolds have spent money on increasing its presence in the vapor category.

The iQOS from Philip Morris is available in 13 markets and continues to expand its presence globally. Recent launches by Philip Morris took the device to big cities like Amsterdam, Athens and Madrid. British American Tobacco has vapor products in 10 markets, with plans of 30 to 40 by the year 2020. A big push is coming in the second half of 2017 with the Vype Raptor.

The biggest success for Philip Morris has come in Japan. The iQOS device has managed to get a 5% market share of the tobacco market in the country, as of October. Share has grown nicely since the product’s inception there. While this is good news, British American Tobacco points out that vaping is banned in Japan and this could just be one country where the iQOS will work.

Alternatives to cigarettes are an important situation for Philip Morris. PM stock will be greatly impacted by the continued decline of cigarette sales around the world. Here are the cigarette volume trends around the world:

  • 2013: -3.3%
  • 2014: -2.5%
  • 2015: -2.4%
  • 2016: -2.0 to -2.5% (forecast)

Philip Morris has a massive market share in the cigarette market around the world. The company enjoyed a global market share of 28.7% in 2015, one of the many reasons investors may be holding onto PM stock. Philip Morris had the following market shares in 2015:

  • Europe: 38.3% (+.2%)
  • EEMA: 25.9% (flat)
  • Asia: 24.8% (+.4%)
  • LA&C: 38.9% (+.2%)

While it’s nice to see Philip Morris concerned about its future revenue stream, it may be throwing in the towel too soon, or committing too much money to an unproven alternative. Through the advancement of the reduced-risk products, Philip Morris has also admitted how harmful its products really are, which could come across as a huge negative. The company said, “Our stated ambition is to convince all current adult smokers who intend to continue smoking to switch to RRPs as soon as possible.”

Another big concern is the sharp decline of smoking rates in China, the world’s largest population of smokers. New statewide bans are coming in China that will make it illegal to smoke in public places, which could cause the number of smokers or frequency to see a sharp decline.

Earlier this year, Philip Morris warned that earnings per share would come in lower because of additional currency woes. The company now sees earnings per share hitting a range of $4.46 to $4.51. In 2015, earnings per share hit $4.42. The low growth of earnings could prove troublesome for a company that has a high dividend payout.

The PM dividend has been raising annually and currently sits at $4.16 per year. The dividend has grown at an annual rate of 8.8% over the last five years.

While normally the Philip Morris dividend has averaged 76% of earnings, the payout ratio now stands at over 91%. This is extremely high and especially worrisome if Philip Morris keeps spending billions of dollars on new, unproven product research. Since the spin-off from Altria, Philip Morris has spent $83 billion on dividends and share buybacks.

PM stock may have gained 79% since being spun-off from Altria Group, but it’s up only 17% over the last five years and in 2016 is actually trading flat. Compare that to former parent Altria, which has seen its shares rise over 120% over five years and up almost 10% in 2016.

Investors may quickly be abandoning the stock as global cigarette demand falls. The latest spending and possible worries about the PM dividend will likely hurt Philip Morris stock as well.

As of this writing, Chris Katje did not hold a position in any of the aforementioned securities.

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