One of the biggest concerns facing investors regarding the tobacco companies is falling cigarette consumption, and they hence are skeptical to put a premium on these companies. A closer look at Philip Morris International (NYSE:PM) however points to a robust economic model and sound cash flow generating ability in the time to come. The stock has climbed more than 12% in 2012 so far, and we believe there is more to come. Philip Morris International competes with tobacco majors like British America Tobacco (AMEX:BTI) and Imperial Tobacco Group (LSE:IMT), among others.
We have a $98.70 price estimate for Philip Morris International, which is about 10% higher than the market price.
Strategy for Europe
Tobacco companies have been raising the prices of cigarettes periodically in Europe to make up for the declining volumes. It’s easy to justify the price increases by blaming the governments and rising input costs. Moreover, the company doesn’t necessarily lose from declining cigarette volumes. Since the value of excise taxes are fixed for a pack of cigarettes (rather than a percentage of selling price), raising the selling prices increases the net revenue per cigarette pack (i.e. revenue – excise taxes) for the company. Besides, declining cigarette volumes could not stop the company from posting growth in overall net revenues. In 2011, the net revenues for the European region grew 4.6% to $9.2 billion. Even in Q1 2012, net revenues rose 2.5% y-0-y.
Philip Morris International’s ability to generate top-line growth in a region which is struggling economically and where demand for cigarettes is showing a decline says a lot about the company’s strong pricing power. Also, note the governments tend to raise excise taxes when they are struggling to meet their respective fiscal deficit targets (tobacco companies are easy targets). If the European economy were to improve in the coming time, we could see excise taxes staying relatively muted. Stable excise taxes can slow down the rate of decline of cigarette consumption.
Asian Markets Carry Growth
Unlike in Europe, demand for cigarettes in other Asian countries is actually showing positive growth buoyed by rising incomes and cigarettes as an integral part of people’s lifestyle. Some of the biggest markets for the company outside Europe are Indonesia, Japan and South Korea. In 2011, Asia displaced Europe as the biggest revenue contributing region.
Philip Morris International’s strategy for developing markets includes moderate price hikes combined with predatory pricing (in some cases) to steal market share which should help the company in the long run. For example, it recently cut the price of Virginia Slims by 14 cents in South Korea as it was facing pressure from KT&G, the region’s dominant player.  In late 2011, the company cut the prices of its premium brand Marlboro by 40% in Senegal to compete against the locally made cigarettes. The move was implemented in spite of the fact that premium cigarettes are taxed at 45% compared to 20% for local brands.
Overall, the picture looks good for Philip Morris International because of the following factors:
(a) Strong global presence including regions which are showing positive cigarette consumption.
(b) Presence of cigarette brands such as Marlboro, L&M and Longbeach which are recognized worldwide.
(c) Ability to generate top-line (as well as bottom-line) growth in stagnant/declining markets.
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- Philip Morris To Cut Virginia Slims Brand Price In South Korea, wsj.com, April 13, 2012 [↩]