Making the Most of Philip Morris

 | Oct 19, 2012 | 3:30 PM EDT
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Philip Morris International's (PM) stock price declined about 4% Thursday after the company reported earnings below analyst expectations. Philip Morris operates internationally after having split from Altria Group (MO), which handles U.S. sales of the old Philip Morris cigarette brands. Revenue at Philip Morris was down in the third quarter, partly due to currency effects and partly due to economic weakness in Europe, among other factors (the company actually raised prices, with the lower revenue resulting from lower sales volumes). Earnings were off slightly, with earnings per share falling to $1.32 compared with $1.35 in the same period in 2011.

Philip Morris' cash flows are large and the company is committed to returning some of this cash to shareholders. It has approved an $18 billion repurchasing program, and, like many other cigarette companies, pays a large dividend yield, 3.7% in this case. Adjusting for the replacement of the third-quarter 2011's earnings in the trailing numbers, Philip Morris trades at 18x trailing earnings. The forward PE ratio is only 15, but reflects the fact that Wall Street analysts expect the company to perform more strongly next year-- even though it has seen lower earnings in both the third and second quarters of 2012 than in the comparable periods last year. Philip Morris would be helped to some degree by more favorable currency movements, but it's probably better not to count on that.

Billionaire Ken Fisher's Fisher Asset Management moved heavily into Philip Morris during the second quarter of 2012, closing June with 2.7 million shares in its 13F portfolio (see more stock picks from Fisher Asset Management). Renaissance Technologies, whose founder Jim Simons is now a billionaire thanks to the hedge fund's strong performance, increased its stake by 41% to 3.9 million shares (research more stocks owned by Renaissance Technologies). Gardner Russo & Gardner had the largest position in the stock out of the 13F filers that we track: it owned 8.1 million shares, which at the end of June was worth more than $700 million. (Find more of Gardner Russo & Gardner's favorite stocks.)

Other cigarette companies include British American Tobacco (BTI), Lorillard (LO), Reynolds American (RAI) and Altria, of course. The entire industry tends towards high dividend yields, and only British American Tobacco, with a yield of 2.6%, makes smaller payments to shareholders than Philip Morris does. The other three cigarette companies all pay at least 5%, and with a tendency toward lower betas as well (they are all at about 0.4, while Philip Morris' beta is 0.9), they are clearly better picks for a defensive investor.

On the value front, Reynolds also trades at 18x trailing earnings while Lorillard and Altria have trailing PEs of only 15. These three companies also trade at small discounts to Philip Morris on a forward basis. In addition, Altria's business has been picking up recently with the other two peers showing little change in revenues; therefore, we would say that Lorillard, Reynolds American, and Altria are all generally better picks. British American, which we've mentioned as paying a smaller dividend, saw both its revenue and earnings come in about flat in the second quarter compared with the same period a year ago. It actually trades at a premium to Philip Morris on a trailing basis, with a PE of 20.

Our conclusion is that Philip Morris looks narrowly better than British American Tobacco. Compared to the rest of its peer group, though, it tends to carry higher earnings multiples and pay lower dividend yields for a business that does not seem to be performing any better.

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