Cigarettes are widely recognized as a consumer staple
. So even with COVID-19 wreaking havoc across the world, most smokers have continued to purchase them at the same frequency as before the pandemic.
With that said, supply chain disruptions and lockdowns have put a slight dent in cigarette sales, and Philip Morris (NYSE: PM) has been no exception.
Net revenue, on a currency-neutral basis, declined by 9.5% yoy in Q2 for the tobacco behemoth.
On the other hand, PM’s adjusted operating income margin surged 200 basis points, helping the company achieve 8% adjusted diluted EPS growth (on a currency-neutral basis), despite the decline in revenue. The operating margin improvement was attributed to “pricing in combustible, manufacturing and SG&A efficiency and the dual RRP margin effect of growing weight and improving profitability.”
Philip Morris CEO André Calantzopoulos recently made headlines when he said:
“I am convinced that it is possible to completely end cigarette sales in many countries within 10 to 15 years, but for that to happen, manufacturers and governments need to work in the same direction.”
While cigarettes will continue to be a large part of Philip Morris’ business for the foreseeable future, the company has taken steps to thrive in the face of long-term industry-wide declines.
A Shift to Smokeless Products
In 2019, Philip Morris sold just over 700 billion cigarettes, down 4.5% from 2018. And over the next few years, CFRA forecasts cigarette consumption to decline by 3% each year.
But heated tobacco products are a different story:
Volumes increased by 44.2% to 59.7 billion units in 2019.
On the back of its IQOS product, Philip Morris has capitalized on the move to heated tobacco products, with volumes in Q2 increasing 24% yoy. RRPs (reduced risk products) now comprise almost 25% of the company’s net revenues, comparing very favorably with Altria (NYSE: MO), which attributes around 12% of sales to smokeless products.
Philip Morris’ growth in its RRP segment, off of a high percentage of overall revenue, gives the company a great chance of more than making up for lost cigarette revenues through RRP products.
And the regulatory environment for smokeless products has been relatively favorable thus far – a welcome sight for PM investors after decades of regulatory hurdles and lawsuits in the cigarette business.
On the Q2 2020 earnings call, CFO Emmanuel Babeau said, “We reached a truly historic milestone for IQOS, our mission and our future growth prospect on July 7, with the FDA's authorization of IQOS as a modified risk tobacco product. IQOS is the first electronic nicotine product to receive an MRTP order. Following a review of our extensive scientific evidence package, the agency found that an exposure modification order for IQOS is appropriate to promote the public health in the United States, demonstrating that IQOS is a fundamentally different product from combustible cigarette and a better choice for adults who would otherwise continue to smoke.”
An Attractive Valuation and Dividend
Philip Morris is trading at around 15x projected 2020 earnings and around 14x projected 2021 earnings. It expects to see sales grow around 7% in full-year 2021, once the pandemic is (likely) behind us.
At first glance, Altria looks like a much more attractive investment, trading at around 10x projected 2020 earnings and around 9x projected 2021 earnings.
But Altria is only expected to see revenue grow 2% in full-year 2021, and its higher reliance on cigarettes puts its future revenue in jeopardy. With that said, its lower multiple compensates investors for this risk, and it is a sound investment at current levels.
Both Altria and Philip Morris pay huge dividends, particularly in our current low-yield environment. Altria’s comes in at around 8% and Philip Morris pays approximately 6%.
Chart is Offering a Nice Entry Point
In the 18 months before the onset of the pandemic, PM hit resistance several times in the mid $80s, failing to break above that level.
Now, shares are trading in the high $70s.
But PM is actually offering a nice entry point right now.
It just broke out of a three-month base where it mostly traded between around $68 and $77 a share. The breakout came on above-average volume and also took shares above the 200-day moving average. Now, shares have pulled back slightly, and currently sit on the 200-day moving average.
If you get in here, you can place a stop-order just below the 50-day moving average, giving you a low downside of around 5%.
The Final Word
Smokeless products appear to the future of the tobacco industry – and Philip Morris is staking its claim in this growing market.
Of course, there is a lot of uncertainty:
- How quickly will cigarette sales decline?
- Can smokeless products replace a large percentage of cigarette sales in the long run?
- Will the regulatory environment remain somewhat favorable for products that are far from risk free?
It’s impossible to accurately answer any of these questions. But the risk/reward on Philip Morris looks attractive and you should seriously consider picking up some shares.
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