Sinful Returns With Philip Morris

By Ryan C. Fuhrmann | April 19, 2009 AAA

Say what you will about sin stocks, but from an investment standpoint they have a number of appealing qualities. Cigarette companies focused on overseas sales, such as Philip Morris International (NYSE:PM), are a potentially addictive option for investors seeking income and stable business models in any economic environment.

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Marlboro
Philip Morris lays claim to the international rights to Marlboro, which sets PM apart from peers such as British American Tobacco (NYSE:BTI) and its stable of secondary brands, including Kent and Lucky Strike. PMI's reported net revenues (which exclude excise taxes) fell 5.5% to $5.6 billion, with the strong dollar reducing sales by $697 million. Excluding currency fluctuations, revenues would have grown 6.3% on an impressive 28% improvement in the Latin America & Canada region, 9% growth in China and single-digit growth in emerging market countries in Eastern Europe, the Middle East and Africa.

Pricing Power
Quarterly cigarette shipment volumes were flat, but "favorable pricing" and strong shipment growth, such as a 100% jump in the Czech Republic, demonstrated that Marlboro has high and growing brand awareness across the globe. In general, tobacco firms have pricing power; U.S.-based Lorillard (NYSE:LO) is relying on price increases to stem a steady slide in the U.S.

Growing Demand
PMI is benefiting from growing demand and pricing power. Management is confident that organic growth will remain strong for 2009 and over the longer haul, and profitability also remains impressive. For the quarter, operating income was $2.37 billion for an operating margin of 42.3% on double-digit improvements (excluding currency movements) in every region except for the European Union, for 8.8% overall growth. Reported operating income fell 7% and diluted earnings ended up falling 6.3% to 74 cents per share.

Bottom Line
The strong dollar masked the extent to which sales are holding up during an acute economic crisis, which isn't all that surprising given that cigarette demand pricing is relatively inelastic and is on a secular upswing overseas. The overseas trends are in stark contrast to trends in the United States where Altria Group (NYSE:MO) is facing falling demand and ever-increasing federal taxes on every pack produced. Reynolds American (NYSE:RAI) is also struggling from a top-line perspective as analysts project full-year revenues will fall about 4%.

Philip Morris' profit margins also illustrate the extent to which it throws off excess capital, which it uses to fund a generous 5.8% dividend yield (as of April 23, 2009) and which it used to repurchase $1.3 billion in stock during the quarter. In the earnings release, management said to expect full-year earnings between $2.85 and $3.00 per share. That puts the forward P/E at under 13 times, which is quite reasonable given the stability of the business and sinfully-healthy growth prospects. (Read The Bottom Line On Margins, to take a deeper look at a company's profitability with the help of profit-margin ratios.)

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