Philip Morris: Will The Source Of Strength Be Strong Enough?

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Philip Morris

Global tobacco giant, Philip Morris International (NYSE:PM) is known to provide generous returns to its shareholders. However, the industry is plagued with numerous problems, right from grappling with falling volumes to dealing with constant regulatory battles. While a number of factors actually work in Philip Morris’ favor, which could ensure security in the short to medium run, potential risks associated with this business might catch up to reverse this trend over the long run. Here are the two factors that could ensure short term gain, but could, in fact, prove to be risky in the long term.

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—  The biggest source of concern for the tobacco business is declining volumes, because of increasing anti-smoking regulation and rising health consciousness among consumers (See Figure). N0w, in order to compensate for losses related to volumes, Philip Morris has continuously increased prices (~40% between 2009 and 2014). Given that tobacco demand tends to be relatively price inelastic, this strategy actually works. Furthermore, Philip Morris does enjoy a certain degree of pricing power given that smokers often display a degree of brand loyalty. Even regulations prohibiting marketing and advertising cigarette brands actually favors big names such as Philip Morris by keeping competition at bay. However, for how long can Philip Morris capitalize on this fact? After a period of time, price hikes may become unsustainable, pushing consumers to resort to illicit means of acquiring cigarettes, along with leading consumers to down-trade to less expensive brands, which could adversely impact the company’s cash flows.

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— At a time when volumes in traditional cigarettes are declining, tobacco companies have sought new avenues such as electronic cigarettes to drive revenues. However, it may not be entirely correct to characterize e-cigarettes as a “new” source of revenue. Essentially, what is happening is, existing smokers who decide to quit smoking, use e-cigarettes to complement their effort at kicking the butt. While there is research indicating that some get on e-cigarettes for the mere attributes of the product, and others who use it along with traditional cigarettes at work and public places, the proportion of these users are not large enough to offset those leaving the traditional cigarette market. In this case, e-cigarettes are nothing more than one avenue that keeps a proportion of those leaving the traditional cigarette market. Furthermore, as more individuals lose nicotine-dependency, this avenue could also start seeing the kind of attrition that traditional cigarettes have been seeing. While research on the impact of e-cigarette usage is still in its inchoate phases, there is no guarantee that this product will not be governed by the same strict laws that have contributed to the decline in smoking rates, after all. In fact, this is expected to kickstart as early as next year, with e-cigarette products undergoing more stringent tests under the EU Tobacco Products Directive.

In conclusion, while Philip Morris could very well deliver in terms of dividends in the short to medium-run, it is questionable whether these tools that it’s banking on will ensure sustainable long-term performance for the company. Apart from this, the company also has much to face in terms of seasonal headwinds that have to do with exchange rates and exposure to emerging markets. These factors could exert an adverse impact on prospects in the long run. However, it must be acknowledged that Philip Morris has been battling almost all of these issues for decades now, in which case, it may be hard to pin-point when exactly the downturn might occur. For the time being, Philip Morris could very well continue to deliver the phenomenal numbers that it has been achieving historically.

Sources:

  1. Why is demand for cigarettes inelastic?
  2. Philip Morris 10-K, SEC
  3. Q4 2014 Earnings Call Transcript
  4. E-cigarette users catching up with smokers: Number of ‘vapers’ in UK tripled from between 2012 and 2014 to reach 2.1million

Other Relevant Analysis:

  1. Philip Morris: Future Prospects And Pressure From Headwinds
  2. Are Tobacco Houses On Their Way To Hitting A Tipping Point Anytime Soon?
  3. Three Factors That Could Positively Impact Philip Morris International

We have a price estimate for Philip Morris’ stock price of around $81, which is above the current market price.

See Our Complete Analysis For Philip Morris International

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