Philip Morris (PM) was down about three percent at one point Wednesday. The cause? What we knew all along: people are smoking less. We learned exactly how much less on Wednesday.
Cigarette consumption is declining at a rate of 2 to 3% globally (according to PM's own figures), 7 to 8% in Europe and a whopping 9 to 11% in Russia. Call me clueless, but I fail to see how PM and related stocks are a buy when their customers are literally disappearing. If automakers were selling 10% fewer cars annually, you would not buy Ford (F) and General Motors (GM). If Hewlett Packard (HPQ) was selling 10% fewer computers, you would not buy HPQ. So why is it that we still love the tobacco names?
It all goes back to the dividend, which in the case of PM, has increased over 100% in five years. The payout ratio is extraordinarily high. PM is A-rated. If you think about it, a company with those kinds of cash flows should be gold-plated AAA. But the company has taken so many bondholder-unfriendly actions that its credit is not quite yet speculative grade. It will probably get there soon (on second thought, the better trade here is probably shorting the bonds or buying five-year PM CDS).
So PM guided lower Wednesday, and the proximate cause was currency hedging losses. The stock does not, however, take a multi-standard deviation dirtnap on currency hedging losses. Investors are nervous about (the lack of) tobacco consumption, which has been lost, in part, due to electronic cigarettes.
E-cigarettes are grabbing market share at an astounding rate. Where I live, in South Carolina, they are everywhere -- in cars, in public places, you name it. The amazing thing is that it is mostly young people using these things. This partially implies that it has become something cool to do. E-cigarette makers have accomplished this with virtually no marketing muscle. It is a product that just makes sense. It delivers a mild stimulant with little or no known adverse health effects.
The remarkable thing about PM's communiqué was that they disclosed that they have moved up the timeline on entering the e-cigarette market from 2016-2017 to the second half of 2014. Even this will be too late -- the e-cig train has already left the station. For what it's worth, Lorillard (LO) is involved and maintains a competitive position. The other tobacco companies are way behind.
I have said it before -- this is an industry that is so dumb that there was no way that any innovation was going to come from within. It's hard to squander that kind of competitive position, but they're doing it. If they manage to survive, it will be because of raw marketing power (if they are allowed to engage in it), or downright underhanded tactics, not because of innovation.
I'm short PM. I've been criticized in the past for shorting -- gasp -- a tobacco company. Even the people who agree with me think I picked the wrong target. PM is the furthest behind in the e-cigarette arms race, and I do not operate under the assumption that the developing world is somehow immune to declines in tobacco consumption.
It took more than a century, but the world is finally waking up to the health dangers of cigarettes. For the first time, there is a reasonably safe and affordable alternative.