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Philip Morris Stock Is About to Get Smoking Hot -- Barrons.com

Barron's · 01/06/2023 04:00
By Teresa Rivas

Philip Morris International's main cigarette business is slowly dying, but the tobacco giant isn't going gently into the night. The company just announced two deals that will keep it healthy in the years to come.

The past decade hasn't been kind to the tobacco business. The number of traditional cigarettes smoked globally dropped from 5.23 billion at the start of 2018 to an estimated 4.69 billion five years later, even as companies raised prices to compensate for fewer packs sold.

Even without the burden of a U.S. cigarette business -- that's been Altria Group's (ticker: MO) problem -- Philip Morris stock (PM) has suffered.

Philip Morris, though, is a different company than it was just a few months ago. Its November acquisition of Swedish Match further cements its global leadership in oral nicotine and adds to its portfolio of what it calls reduced-risk products, which don't require users to burn tobacco. That deal closed a month after it paid Altria $2.7 billion for the rights to sell Philip Morris' flagship IQOS product in the U.S., marking PM's first return to the domestic market since the two companies split in 2008.

Together, the deals mean Philip Morris could have a longer, brighter future than many investors had feared.

"They are further proof that Philip Morris is on a path to be a durable, profitable, and growing business for a very long time to come," says Bryan Engler, a portfolio manager at Kovitz Investment Group Partners.

That future begins with those euphemistically termed reduced-risk products, or RRPs. These include IQOS, which heats tobacco instead of burning it, along with vaping and nasal and oral products, such as snuff and chewing tobacco.

With global cigarette sales falling steadily over the past decade, Philip Morris isn't the only company branching out: E-cigarette sales alone ballooned nearly sevenfold, to $2.1 billion, from 2015 to 2018, the year that Altria made a $12.8 billion investment in vaping company Juul.

Critics charge that smoke-free tobaccos are still carcinogenic and that vaping might pose health risks. Yet even the Food and Drug Administration acknowledges that some tobacco products, including IQOS, reduce the production of harmful chemicals, compared with combustible cigarettes.

Philip Morris is betting on being the lesser evil. By 2025, the company wants over half of its sales to come from smoke-free products, and the string of recent moves makes that goal more reachable. Philip Morris' RRP business grew 33.5% in 2021, to more than $9 billion, or 29% of sales, up from just over 13% in 2017. IQOS' expected 2024 U.S. relaunch should offer some stabilizing dollar-denominated sales to offset foreign-exchange risk, while giving it access to one of the most profitable nicotine markets in the world.

No other cigarette maker is close. Altria still gets more than 84% of its revenue from combustible cigarettes, while British American Tobacco (BTI) gets nearly 86%. All told, Philip Morris has 28% of the global cigarette market, but 59% of the global smokeless tobacco market, according to Cowen analyst Vivien Azer. "Philip Morris' advantaged competitive position will prove defensible, at least for the midterm," she says.

And profitable, too. Steady increases over the years have proven tobacco's pricing power -- a crucial advantage in an inflationary environment. While the eventual exit from Russia, plus currency headwinds, and IQOS research and development costs are expected to cause earnings per share to edge lower this year and next -- to $5.71 and $5.69, respectively -- that's coming off an all-time high of $6.08 in 2021.

Wall Street expects Philip Morris to return to record per-share profits of $6.68 in 2025. Profit margins should widen, too, given that the most intensive spending on development and marketing is largely in the past. Gross margins already jumped to 68.8% in 2021, above the company's five-year average of 65.5%.

"A cigarette is by far the most profitable consumer product in existence, with very fat margins," says Dan Ahrens, portfolio manager of the AdvisorShares Vice exchange-traded fund (VICE).

Some of these advantages are already reflected in Philip Morris stock. At 17.8 times 2023 earnings, it's trading above its own five-year average of 15.4 times, and higher than Altria, British American Tobacco, and Japan Tobacco (2914. Japan), which fetch 9, 8.4, and 10.4 times, respectively.

Still, the Philip Morris is cheap, compared with other consumer-staples stocks, including Procter & Gamble (PG), Coca-Cola (KO), and PepsiCo (PEP), which fetch around 25 times, even as Philip Morris boasts higher gross margins.

"Philip Morris is getting the world to use fewer cigarettes," Kovitz's Engler says. "If you believe it will be around for a long time, why shouldn't it trade at levels like the rest of the best-in-class consumer packaged goods companies?"

The answer is clear. Philip Morris is still a company that sells a legal, addictive substance that could eventually kill customers. But ESG -- short for environmental, social, and governance -- investing is changing, and some investors are focusing less on exclusion and more on change.

"ESG is very complicated, and it's often in the eye of the beholder," says Ahrens, who notes that so-called sin stocks can also do good. "Philip Morris is doing a great job with RRPs, and that's a socially responsible thing to do."

Philip Morris might only be cleaning up its own mess, but it's doing so profitably, something many other companies have not. At a recent $101, its stock looks like a buy.

Write to Teresa Rivas at teresa.rivas@barrons.com

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January 06, 2023 04:00 ET (09:00 GMT)

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