Notwithstanding an impressive 32% recovery since the March 23 lows of this year, at the current price of $79 we believe that Philip Morris stock (NYSE: PM) has the potential to rise further. PM’s stock has increased from $60 in March to $79 currently as against the S&P 500 which clocked a 45% rise during the same period. PM has underperformed the market as the fall in the stock price in the first place during the crisis was lower than the broader market, with PM being a part of the tobacco industry which is largely considered to be a defensive sector. Despite rising 32% in 4 months, PM’s stock price is still about 14% lower than the pre-crisis peak (February 2020) and levels seen at the end of 2017. We believe the gradual lifting of lockdowns could usher in a further rise in the company’s stock price, which has a potential upside of around 8% from current levels. Our dashboard What Factors Drove -14% Change In Philip Morris International Inc Stock Between 2017 And Now? has the underlying numbers.
The drop in PM’s stock price between 2017-2019 is justified by the 24% decline in P/E multiple from 24x in 2017 to 18x in 2019. The multiple went further down this year to about 13x in March 2020 following the outbreak of the pandemic, but has since recovered and currently stands at 17x. This is despite the fact that Philip Morris revenues increased by 3.7% from $28.7 billion in 2017 to $29.8 billion in 2019 while net income margin went up from 22% to 26% during the same period. On a per share basis, earnings increased 19% from $3.88 in 2017 to $4.61 in 2019, as shares outstanding did not see much change.
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Despite rising revenue and margins, P/E declined since 2017 mainly because the revenue growth was driven by charging higher prices for cigarettes, while changing consumer preferences led to a steady drop in the number of cigarettes sold. Also, over recent years, consumers have increasingly bought e-cigarettes (like PM’s IQOS brand), but the regulatory crackdown against flavored e-cigarettes and a global debate around the safety of such products led to a decline in P/E multiple and thus stock price.
What’s the likely upside?
The global spread of coronavirus which led to lockdown in various cities across the globe, affected industrial and economic activity, in turn adversely affecting consumption and consumer spending. Despite tobacco being a defensive industry, PM’s stock was affected by the crisis as Philip Morris’ operations are spread across continents, which meant that the lockdowns imposed significant impediments in its global supply network. This was partially reflected in PM’s Q1 2020 results, where cigarette shipments saw a y-o-y drop of 4.4%. However, actual impact of the crisis was felt in the recently announced Q2 2020 results, where PM reported a 17.6% y-o-y drop in cigarette shipments, with total revenue seeing 13.6% decline while earnings dropped 16%.
However, over the coming weeks we expect continued improvement in demand and subdued growth in the number of new Covid-19 cases in the US compared to the rate seen in April-May to boost market expectations. Additionally, the gradual lifting of lockdowns is also giving investors confidence that developed markets may have put the worst of the pandemic behind them. Following the Fed stimulus — which helped set a floor on fear — the market has been willing to “look through” the current weak period and take a longer-term view, with investors now mainly focusing their attention on 2021 results.
As the global lockdowns are gradually being lifted, Philip Morris’ supply constraints are expected to ease over the coming months, with the second half of 2020 likely to be much better than the first six months. Rising demand for IQOS, higher cigarette prices, and normalized supply network could result in healthy revenue and margin growth in 2021. Also, as investors’ focus having now been shifted to 2021 numbers, the market is likely to overlook the near term volatility. A situation where Covid cases rise significantly and lockdowns are re-imposed could be a hiccup in the road toward the stock price rise for the company. But in the absence of any further lockdowns like were seen in the last few months, the stock is likely to see around 8% potential upside from its current level. As per Philip Morris valuation, Trefis has a fair price estimate of $85 per share for PM’s stock.
For further insight into the tobacco space, see why PM’s rival Altria’s stock fell over 30% with revenues being almost flat