Philip Morris In Emerging Markets: Will Costs Outweigh Benefits?

Philip Morris International (NYSE:PM) and other large firms have been betting on the emerging market phenomenon to guarantee growth. At a time when anti-smoking regulations and increasing health awareness regarding smoking have been a drag on results in developed markets, these emerging markets that had been showing phenomenal growth over the last decade held promise. However, emerging markets more recently have been troubled, with a number of nations displaying tough economic situations. In a previous article, we established that the core contributors to this development, namely the Quantitative Easing (QE) taper, economic slowdown in China, and declining commodity prices, were here to stay, at least in the short to medium term. In this case, are emerging economies too costly in terms of the risks they pose? Probably not, and here’s why.

Annual GDP growth (in%) for developing nations, The World Bank

The recent developments in emerging economies could be one that is cleansing the economies of these countries to lead to what can be described as more sustainable growth. Let’s look at China, for instance. China’s double digit growth in the past was bound to become unsustainable at some point. And even at 7%, China’s incremental output growth today is far higher than what the country was attaining at a 14% rate a decade ago. Moreover, although China’s manufacturing activity measured by the Purchasing Manager’s Index (PMI) hit record-lows in recent months, less is spoken of the less traditional consumer sector, which has actually grown. According to a report by Lazard, China’s retail sales have increased 10.8% in August on a year-on-year basis, which might even be understated since the calculation methodology does not account for e-commerce sales, which is a budding domain. Furthermore, the report also acknowledges some sort of revival in China’s property markets, where sales have increased after periods of downturns. ^[1] Clearly if this is true, China could just be in a transition phase and actually prove to be less risky for businesses in the longer term.

Next, let’s move on to commodity prices, in particular, oil prices. Fundamentally, oil prices, to an extent, are influenced by market forces. And in spite of the low prices that the commodity is trading at presently, there could be reasons for revival in the future. While demand for oil could remain low as China continues to slowdown and developed nations exhaust economic stimulus and quantitative easing to steer growth, supply shocks could lead to price increases. Historically, the OPEC has controlled supply in response to demand side changes to ensure stability in price. However, now that OPEC has been focusing on maintaining market share, which is why supply has not waned even against falling demand to contribute to the price decline. However, not every oil producer can afford to continue supplying at the current rate, leading to some firms dropping out of the market. Moreover, the declining profitability of the business could keep new entrants at bay. These two factors could lead to a reduction in supply to lead to a price revival. Furthermore, the recent slump in oil prices and the consequent damage to the economies of countries that rely almost entirely on oil exports, could be a lesson that could lead them to explore other avenues to steer the economy. In fact, in Russia’s 2016 budget, President Vladimir Putin already has acknowledged the economy’s high dependence on oil and has formulated policies to reduce this dependence. ^[2] In this situation, the current crisis in oil exporting countries could actually lead to developments that actually safeguard them from such a situation in the future.

While there could be some reprieve when it comes to China’s growth and commodity prices, emerging markets could face more volatility going forward in light of the U.S. monetary tightening. Although the Fed resisted a rate hike in September, the Fed could increase rates in December. Regardless of what the Fed does, the anticipation of this rate hike has already exerted it’s impact on countries such as Brazil, Russia, South Africa, and Turkey, who have been riddled by high debt, inflation, and currency depreciation. Moreover, after the first cycle of interest rate hikes, emerging markets could see further capital flight in anticipation of another round of monetary tightening at a later date.

Going back to what all this could mean for a company like Philip Morris.  Clearly, emerging markets are in a bit of a soup recently and could very well continue displaying these trends over the next 4-5 years. However, one major factor that comes out of this for the business world is efficiency. This could be the economy’s way of cleansing itself, which could result in inefficient firms across industries dropping out and the efficient firms staying. Clearly, conglomerates like Philip Morris have the strategic insight and capital to stay afloat during these tough times. While waning demand and difficult economic conditions could prove to be a drag on financial results over the next few years, the company could effectively eliminate competition from existing players and potential entrants, along with devising efficient cost savings during this time, that could lead to long-term success.

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

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1. Outlook On Emerging Markets [↩]
2. Putin urges to cut Russia’s economic dependence on oil prices [↩]