Philip Morris International (NYSE: PM) is considered a conservative income play that sometimes underperforms the market but stays resilient during market downturns. But the tobacco giant, which has generated all its revenue overseas after being spun off of Altria (NYSE: MO) in 2008, is generally much tougher to analyze than its domestic counterpart.
On one hand, most of PMI's overseas markets have higher adult smoking rates than the U.S., which gives it stronger growth potential than Altria. But on the other hand, PMI is heavily exposed to currency headwinds -- and the strength of the U.S. dollar is gobbling up its overseas revenue. Let's take a closer look at these headwinds and tailwinds to see if PMI stock will sink or swim this year.
Why Philip Morris International could sink
The biggest headwind for PMI is the strong dollar. A look at the disparity between PMI's constant currency and net revenues reveals how badly the dollar's strength throttles its top line growth.
Net revenue growth
Constant currency revenue growth
Source: PMI quarterly reports, excludes excise taxes.
Unfortunately, the dollar could remain strong this year, due to upcoming interest rate hikes and worldwide macro problems making the dollar a top "safe haven" currency. PMI expects its net revenues (excluding excise taxes) to rise 4%-6% on a constant currency basis in 2017, and for its earnings to grow 9%-12%. But after factoring in an estimated $0.18 impact from currency headwinds, its reported earnings are only expected to rise 1%-4%.
As U.S. interest rates rise, many income investors will likely dump high-yielding dividend stocks for bonds. That secular shift could hurt both PMI and Altria, which have respectively rallied 16% and 20% over the past 12 months on their appeal as conservative income stocks. Moreover, PMI's P/E of 23 is now higher than the industry average of 21 and hovering near a multi-year high -- which makes it very vulnerable to a sell-off.
Meanwhile, PMI's overseas growth has hit a lot of speed bumps. In Indonesia and Latin America, shipments are slipping due to soft economic environments and higher excise taxes. PMI has also engaged in costly, seemingly endless litigation with government regulators over new anti-smoking regulations. Lastly, PMI could face increased competition from British American Tobacco (NYSEMKT: BTI) , which recently agreed to acquire Reynolds American (NYSE: RAI) to become the biggest publicly listed tobacco company in the world.
Why Philip Morris International could swim
Those headwinds seem fierce, but investors shouldn't overlook PMI's key strengths. First, its 4% yield remains very attractive compared to the S&P 500's 2% yield, Altria's 3.2% yield, and the 10-year Treasury note's 2.4% yield. This means that the fears about higher interest rates triggering a sell-off of high-yielding blue chips could be overblown.
Macro and currency headwinds seem tough right now, but these trends are generally cyclical. This means that if some of PMI's weaker markets perk up and the dollar weakens, its turnaround could be swift and amplified by easy year-over-year comparisons. Moreover, PMI can keep raising prices to offset declining cigarette shipments -- a strategy which has supported its profits for decades.
PMI could also acquire more local brands or launch new products to boost its top line growth. For example, PMI bought Indonesia's Sampoerna, Pakistan's Lakson Tobacco, and Canada's Rothmans to take control of those countries' leading local brands. There's also rampant speculation that PMI could buy Altria to recombine both halves of Philip Morris to compete more effectively against British American Tobacco.
As for new products, PMI recently launched iQOS, a device which heats tobacco "heatsticks" instead of burning them as a lower-risk alternative to e-cigarettes. Those devices captured over 5% of the Japanese cigarette market at the end of 2016. PMI has also acquired various e-cigarette brands across the world to expand its smokeless portfolio. These moves all indicate that PMI can still scale up and diversify its top line to keep growing -- despite all the challenges facing the traditional cigarette market.
So will Philip Morris International sink or swim?
I believe that PMI remains a stable income play for conservative investors, although concerns about the strong dollar and interest rate should cause some near-term turbulence. But over the long term, PMI will likely continue consolidating the market, launching new products, and streamlining its business to support its top and bottom line growth.
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