Back in 2008, Altria (NYSE:MO) spun off its Philip Morris operations. One reason was to lessen the reputation problems of the U.S. business because of the growing resistance to smoking.  What’s more, Philip Morris would be a pure-play in the faster-growing global markets.

The financial engineering has worked out quite well.  Over the past three years, Philip Morris (NYSE:PM) has generated an average annual rate of return of 14.2%.  In fact, the stock is up a nifty 23.7% this year. 

Is Philip Morris still a good bet for investors?  Let’s take a look at the pros and cons:

Pros

Mega brands.  For Philip Morris, these include Marlboro, L&M, Parliament, Chesterfield and Bond Street cigarettes.  They are premium brands that should continue to grow as wealth increases in Asia and other emerging markets.  Keep in mind that Philip Morris has nearly 30% of its revenue from this region.  There is also a strong footprint in the Middle East, Africa and Eastern Europe.

Cash Cow.  Operating margins are around 40%, which are certainly juicy.  In the latest quarter, free cash flow increased by 22.6% to $2.2 billion.  Because of this, Philip Morris has been aggressive with its stock repurchases as well as acquisitions. 

Innovation.  Philip Morris recently purchased a patent for a smokeless cigarette based on an aerosol nicotine delivery system. It’s a smart move as Philip Morris realizes it needs to be prepared for inevitable changes in the laws and lifestyles. However, it looks like the technology is still in the early stages and will take years until it becomes commercially viable. 

Cons

Secular trends.  Over the past few decades, there has been a big fight against the tobacco industry.  The result has been declining growth and huge legal liabilities – especially in the U.S.

It should be no surprise that there will be similar reactions in other countries.  More restrictive anti-smoking laws would certainly be a damper for Philip Morris. 

Economy.  There are signs that Asia is being hit with slower growth.  True, the volume drops may still not be great, and, of course, smoking is highly addictive.  But there are concerns that tobacco companies may engage in price wars to maintain market shares.

Taxes.  The smoking industry has been a fat target.  Also, as government budgets get tighter, it will be tempting to increase excise taxes on cigarettes.  This will put pressure on margins.

Counterfeit products.  This is a big problem for the tobacco industry.  In fact, the illegal market for cigarettes is growing at a rapid pace and is a crimp to revenue.  Actually, the Marlboro brand is the one that has the most international counterfeited activity. 

Verdict

Philip Morris is not for all investors.  No doubt, it has a certain amount of taint and controversy.

But the company still has many attractions as an investment.  The dividend offers a nice 3.8%  yield and there should be respectable growth for the long haul.  The major share repurchases should also be a boost.

In light of all these factors, the pros outweigh the cons for the stock.

Tom Taulli’s latest book is “All About Short Selling” and he has an upcoming book called “All About Commodities.”  You can find him at Twitter account @ttaulli.  He does not own a position in any of the stocks named here.