We think that Altria stock (NYSE: MO) is currently a better pick compared to Philip Morris stock (NYSE: PM). Altria stock trades at a trailing P/S multiple of about 3x, compared to around 4.4x for Philip Morris. Does this gap in Altria’s valuation make sense? The contrast is not a whole lot better if you look at the last twelve months (LTM) revenues for Altria, which have seen a y-o-y growth of 2.5% compared to a decline of 2.1% in the case of Philip Morris. Go back another twelve months and you will see a y-o-y decline of 0.5% in Altria’s revenues, much less than 2.7% drop in the case of PM. Then why is there a mismatch in the multiples?
Although both companies were not severely affected by the pandemic as they belong to the defensive tobacco sector, Altria has recorded significant impairment in the value of its recent acquisitions (JUUL and Cronos) due to US regulatory crackdown on flavored e-cigarettes. Philip Morris stock has been backed by investors due to its geographic diversification and strong performance in e-cigarettes. However, there is more to the comparison. Let’s step back to look at the fuller picture of the relative valuation of the two companies by looking at historical Revenue Growth as well as Operating Income and Operating Margin growth. Our dashboard Philip Morris International Inc vs. Altria Group, Inc: PM stock looks slightly overvalued compared to MO stock has more details on this.
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1. Revenue Growth
Between 2016 and 2019, Philip Morris revenues increased 11.6%, from $26.7 billion to $29.8 billion. The increase was largely driven by strong demand and rising shipments of its IQOS brand (smokeless tobacco product) as people are largely moving away from combustible tobacco (cigarettes). On the other hand, Altria’s revenue declined over 2% from $25.7 billion in 2016 to $25.1 billion in 2019. This was mainly due to lower cigarette shipments as consumers are switching to smokeless options due to health concerns. However, the revenue trend seems to have reversed over the last twelve months when Altria’s revenues increased 2.5% while PM’s revenues dropped 2.1%. Revenue growth was driven by higher pricing of cigarettes and recent acquisitions.
2. Operating Income
Despite increasing initially, Philip Morris’ operating income in 2019 went back to its 2016 level of $9.9 billion. The decline in 2019 was driven by higher marketing investment behind non-combustible products. Operating margins declined from 37% in 2016 to 33% in 2019. Contrast this with Altria, which saw a significant drop in its operating profit from $22 billion in 2016 to $0.8 billion in 2019. Such a sharp drop in profits was driven by significant impairment charges reported in 2019, as the value of Altria’s investment in JUUL and Cronos was scaled down. With these impairments still being recorded, PM’s operating income over the last twelve months has been more than 3x Altria’s, though both are seeing an improvement in the metric.
The Net Of It All
Although PM’s revenues have increased steadily over recent years as against a drop in MO’s revenues, the trend has reversed over the last twelve months, with MO’s revenue growth being much better than PM’s. Altria’s revenue is expected to continue rising going forward as the company benefits from its foray into e-cigarettes with the acquisition of JUUL. Additionally, the FDA approval for the sale of IQOS in the US is also projected to help the company grow its top line going forward. With most of the impairment charges already recorded, Altria’s operating income is also expected to rise in 2021 and ahead. Also, as the market opens up further and demand for e-cigarettes steadily grows, there is a possibility of Altria’s investment value in JUUL and Cronos to be scaled upwards, which will provide a further boost to its margins. Even in the absence of a partial impairment reversal, rising volume of smokeless products and higher pricing of cigarettes will drive margins higher. Philip Morris is unlikely to see as much growth in its margins as Altria due to PM’s already higher base and increased marketing expenditure.
Thus, Altria is likely to perform better in the coming quarters and years, with a superior margin growth along with expansion of its top line. As such, we think the difference in P/S multiple of 4.4x for Philip Morris versus 3.0x for Altria will likely narrow going forward, implying better returns for Altria’s stock. As per Philip Morris valuation, Trefis has a price estimate of $85 per share for PM’s stock, 5% higher than its current market price. As per Trefis, Altria’s valuation works out to $48 per share, reflecting a potential upside of 15% from the current market price.
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