Philip Morris (PM) Gains Despite Tobacco Industry Headwinds

Tobacco leader, Philip Morris International Inc.PM has managed to entice investors, despite the health-related concerns associated with tobacco. This Zacks Rank #3 (Hold) stock has outpaced both the Zacks categorized Tobacco industry and the broader sector on a year-to-date basis. The stock rallied nearly 29%, way better than the industry's addition of 20%. Meanwhile, the Zacks categorized Consumer Staples sector, of which they are part of, gained 9%. In addition, it boasts a long-term earnings growth rate of 10.8%, which highlights its growth potential.

Let's Delve Deep

We note that Philip Morris is aggressively investing in creating smoke-free products in order to replace harmful cigarettes. The company intends to invest an additional €500 million to expand its Crespellano facility in Bologna, Italy. The expansion of the facility is expected to be completed by the end of 2018 and is considered to be a valuable step in achieving its vision of creating smoke-free products.

Prior to this, the company had announced to invest roughly $320 million for building a smoke-free product facility in Dresden, Germany. This facility will be wholly operational early 2019 onwards and will manufacture HEETS, the tobacco units for the electronic tobacco heating device IQOS (Heatsticks that heat tobacco instead of burning it). Additionally, the company plans to convert the cigarette manufacturing factory of its affiliate in Greece to IQOS tobacco unit.

It is to be noted that IQOS, a smokeless cigarette, was launched in Nov 2014 owing to declining smoking rates in developed countries. This is expected to support the tobacco industry's move toward reduced-risk products, which may eventually replace the traditional ones.

Meanwhile, Philip Morris continues to benefit from its strong portfolio of tobacco brands and pricing power. In fact, the company has always managed to remain afloat and generate revenues with higher cigarette pricing in the face of unfavorable tax environment and declining cigarette volumes. Additionally, the agreement between Philip Morris and its peer Altria Group, Inc. MO is boosting the businesses of both the companies and will help the companies maintain market share.

However, the company has been witnessing a decline in demand for cigarettes due to the ongoing anti-tobacco campaigns and price rise to offset the rising taxes. Also, the tobacco industry has been facing many challenges, which may pressure the company's margins. Evidently, its adjusted operating margin was down 80 basis points to 41.1% in first-quarter 2017.

Furthermore, the restrictions imposed on tobacco companies are lowering cigarette consumption. The U.S. Food and Drug Administration (FDA) has made it mandatory for tobacco companies to use precautionary labels on cigarette packets to dissuade customers from smoking. These regulations adversely impact the company's top line and, in turn, its overall profitability.

Bottom Line

Despite these headwinds, we believe the company's strong pricing power and focus on accelerating IQOS volume growth will help deliver upbeat results in 2017. In fact, the Zacks Consensus Estimate of $4.89 and $5.54 for 2017 and 2018 has increased 0.4% and 0.9%, respectively, in the last 30 days.

Meanwhile, investors can count on some better-ranked stocks in the broader Consumer Staples sector that include Constellation Brands, Inc. STZ and Aramark ARMK sporting a Zacks Rank #2 (Buy). You can see the complete list of today's Zacks #1 Rank (Strong Buy) stocks here .

Constellation Brands delivered an average positive earnings surprise of 7.7% over the trailing four quarters and has a long-term earnings growth rate of 17.8%.

Aramark pulled off an average positive earnings surprise of 4.5% over the trailing four quarters. Also, it has a long-term earnings growth rate of 12%.

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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