Philip Morris will avoid the problems faced by companies who have built their future on the U.S. market. Witness how, when the FDA made a formal announcement of its intent to lower nicotine levels in cigarettes to a non-addictive level, shares of tobacco stocks with U.S. exposure plummeted. These stocks have have yet to recover. Since the announcement, Altria Group Inc (NYSE:MO) is down over 12%, and British American Tobacco PLC (ADR) (NYSE:BTI), which recently completed its acquisition of Reynolds American has been similarly hit hard, down double-digits as well.
Meanwhile, Philip Morris International Inc. (NYSE:PM) has been flat over that same period, unperturbed seeing as all of its revenues are derived from non-U.S. markets, where incidentally, the regulatory environment tends to be less severe and user growth still has plenty of room to accelerate.
Now, the FDA has presented a multi-year road map, so while some may argue that the actual nature of its execution is uncertain, there is nothing uncertain about the regulatory agency’s intent.
Philip Morris is where the Growth is
The world is Philip Morris’ oyster. Currency fluctuations have hit Philip Morris rather hard this year, but the underlying business is sound and on-track to achieve top line growth of 9-12% for the full-year, according to a 2Q earnings presentation.
Second quarter net revenues were up 7% and adjusted diluted EPS up 8.7% (constant currency) year-over-year for the second quarter. Even though shipment volumes have seen declines across the industry, the company has shown sequential improvement relative to the first quarter. The portfolio mix and pricing power of its products allow Philip Morris to post respectable growth figures throughout market cycles.
Marlboro continues to build its brand equity abroad and take market share in a number of markets including Indonesia and the Philippines. PM is on its way to making Marlboro an even more dominant brand in the premium category, and there still is lots of share to take.
On the smokeless side, where these alternatives would meet additional scrutiny in the U.S., PM is free to continue to market and distribute as it sees fit. Second quarter earnings showed exceptional IQOS performance backed by a strong Korea launch. Between the cigarettes and smokefree products, Philip Morris is extremely well-positioned to growth in the double digits in the foreseeable future.
Altria has a Bumpy Road Ahead
Altria has historically been extremely savvy about navigating a complex regulatory environment. The sphere of public health is a delicate one, yet the Company has managed this risk well. Sales growth (even post the PM spinoff) and consistent dividend hikes (over 4%) show Altria to be a very robust cash flow generating business. The numbers show that regulations thus far have had a relatively benign effect on performance.
But things are getting harder.
FDA Commissioner, Scott Gottlieb, envisions “a world where cigarettes would no longer create or sustain addiction, and where adults who still need or want nicotine could get it from alternative and less harmful sources…” This, he says, “needs to be the cornerstone of our [the FDA’s] efforts – and we believe it’s vital that we pursue this common ground.”
The headwinds for Altria has started blowing in earnest. It’s no gale force blizzard yet, but the increasingly challenging regulations especially as applied to the line of innovative e-cigarettes (one of Altria’s prime supplements for future growth) are a big concern. The new enforcement policy that the FDA will undertake won’t alter the current requirements for cigarettes and smokeless tobacco, cigars and e-cigarettes will be subject to additional compliance and marketing restrictions.
Even trading at a P/E of 8.3x, Altria is still not quite de-risked enough for me. I’d much rather pay a bit more for Philip Morris with its strong macro narrative.
As of this writing, Luce Emerson did not hold a position in any of the aforementioned securities.
