Despite rising more than 45% from its March 2020 lows amidst the coronavirus pandemic, Philip Morris stock (NYSE: PM) still appears to be undervalued. PM stock has rallied from $61 to $89 off its recent bottom as against the S&P 500 which increased close to 80% from its 2020 lows. PM’s stock has underperformed the market as the drop in the stock price during the coronavirus crisis was much less than the broader market’s drop in the first place. Thus, the recovery has been lower than the market’s. In any case, a 45% rise in a defensive stock is impressive. The stock is currently at a three-year high, 33% above levels seen in December 2018. Despite this, it still has a modest upside remaining. We believe that the gradual lifting of lockdowns will lead to higher shipments and revenues as supply constraints ease. With the trend of moving away from combustible tobacco products to e-cigarettes continuing to pick up, the company’s focus on its e-cigarette brand IQOS will help it further increase its market share, revenue, and earnings. We believe that PM stock still has a potential upside of close to 10% even after a healthy rally in the last one year. Our dashboard Philip Morris International Inc (PM) Stock Has Gained 33% Between 2018-End And Now has the underlying numbers behind our thinking.
The stock price rise between 2018-2020 is justified by 5% improvement in profitability, as PM’s net income margins increased from 26.7% in 2018 to 28.1% in 2020. This was despite Philip Morris’ revenues falling 3% from $29.6 billion to $28.7 billion during this period. Lower revenue was mainly driven by cigarette and heated tobacco unit shipment volume going down by 8.1% amidst the lockdowns imposed during the pandemic, which affected supply chains. However, margins increased during this period mainly because of lower cost of sales, reduced marketing expenditure, and lower excise taxes. As earnings improved and shares outstanding remained stable, on a per share basis, the company’s earnings increased 1.6% between 2018-2020.
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The most critical factor in driving stock price growth over the last few years has been the P/E multiple which has shot up 30% from 13x in 2018 to 17x at the moment. This has mainly been a reflection of improving margins and healthy growth in the e-cigarette segment. We believe the P/E multiple will remain elevated close to its current level, led by expectations of healthy revenue and earnings growth over the next few quarters and more people switching to heated tobacco products like IQOS.
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 geographies, with the lockdowns imposing significant impediments in its global supply network. This was reflected mainly in PM’s 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%. For the full year 2020, PM’s revenues declined 3.7% y-o-y.
With the global lockdowns gradually being lifted, Philip Morris’ supply constraints are expected to ease over the coming months. Shipments and sales numbers are expected to pick up from 2021. The actual recovery and its timing hinge on the broader containment of the coronavirus spread. Our dashboard Trends In U.S. Covid-19 Cases provides an overview of how the pandemic has been spreading in the U.S. and contrasts with trends in Brazil and Russia. Rising demand for IQOS, higher cigarette prices, and a normalized supply network could result in healthy revenue and margin growth 2021 onward. As investors’ focus has now shifted to 2021 and 2022 numbers, the market is likely to overlook the near-term volatility. The recent spike in Covid-positive cases in Europe and the U.S. is a cause for worry for the company as re-imposition of another lockdown will be a major impediment to the stock’s recovery. However, another major lockdown looks unlikely as of now. In the absence of any further lockdowns such as were seen in the first half of 2020 and the rollout of a successful vaccination program, PM’s stock is likely to rise further. As per Trefis, Philip Morris Valuation works out to $96 per share, reflecting a potential upside of close to 10% from its current level.
While Philip Morris stock may have moved, 2020 has created many pricing discontinuities which can offer attractive trading opportunities. For example, you’ll be surprised how the stock valuation for Coca-Cola vs Merck shows a disconnect with their relative operational growth. You can find many such discontinuous pairs here.