The Consumer Staples sector seems to be in good shape. A rebound in oil prices from all-time lows, an improving labor market and a resurgent housing market are raising buyers’ confidence. Also, encouraging manufacturing index readings issued by the Institute of Supply Management (ISM) also hints at a pickup in GDP, indicating that economy is on a recovery mode.
Headwinds Plaguing Tobacco Industry
However, tobacco industry, which is part of the consumer staples sector, is failing to draw investors’ attention due to industry-wide headwinds. We note that governments around the world have been imposing stringent restrictions on tobacco companies to lower cigarette consumption, which is severely impacting businesses of tobacco giants including Altria Group Inc. (MO - Free Report) , British American Tobacco p.l.c. (BTI - Free Report) and Vector Group Ltd. (VGR - Free Report) .
In July, the U.S. Food and Drug Administration (FDA) proposed to lower nicotine levels in cigarettes, as tar and other substances inhaled through smoking is detrimental to health. Not only this, the FDA has made it mandatory for tobacco companies to use precautionary labels on cigarette packets to dissuade customers from smoking. The European Union and the FDA have proposed a ban on menthol in accordance with the Tobacco Control Act. Per the act, menthol has an adverse effect on health and thus should not be used in any product.
Amid increasing government restrictions and declining smoking rates, the tobacco giants have introduced e-cigarettes and Reduced Risk Products to mitigate losses. However, the FDA also imposed several restrictions on e-cigarettes. The FDA made it mandatory for all tobacco makers to seek marketing authorization for any tobacco product introduced after Feb 15, 2007. The law was extended to include e-cigarettes, pipe tobacco, cigars and hookah. The FDA has currently deferred its reviews for products like cigars and hookah tobacco until 2021 and e-cigarettes until 2022.
Amid such a scenario, let us take look at Philip Morris International Inc. (PM - Free Report) and see if it can be a good choice for investors. The company’s sales have declined in six out of the last seven straight quarters due to lowering cigarette shipment volumes. Also, its earnings have posted negative surprise in five out of the last seven quarters.
Why Philip Morris is a Viable Investment Choice?
Shares Gaining Momentum: Despite declining cigarette volumes, Philip Morris continues to benefit from its strong portfolio of tobacco brands and pricing power. Further, the company is churning its portfolio and taking steps to develop smoke-free products called reduced risk products. In fact, Philip Morris remains focused on the growing e-cigarette category and less harmful alternative tobacco products such as HeatSticks and iQOS and expects the same to deliver growth in 2017. The strong fundamentals of the company are reflected in its share price movement. Philip Morris has outperformed the Zacks Tobacco industry and the broader Consumer Staple sector on a year-to-date basis. The stock has moved up 28.9% in the said time frame, higher than the industry’s growth of 10.7% and the sector’s increase of 11.2%.
Favorable VGM Score: Philip Morris, with a Zacks Rank #3 (Hold) flaunts a VGM Score of B, which makes it a favorable investing option. You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.
We note that the VGM Score is a comprehensive tool that will allow investors to filter through the standard scoring system and choose better winning stocks. In order to screen out potential winning stocks, we consider only those that have a Zacks Rank #1 or #2 (Buy) and a VGM Score of A or B.
Valuation Multiples: If we look into the company’s EV/EBITDA and P/S multiples, we note that the company generally trades below its industry average.
Philip Morris has a EV/EBITDA multiple of 18.4. This level actually compares pretty favorably with the industry at large, as the EV/EBITDA multiple for the industry is pegged at 32.6. This indicates that the stock is relatively undervalued right now, compared to its peers.
Right now, Philip Morris has a P/S ratio of 2.4. This is significantly lower than the industry average of 2.8 and S&P 500 average, which comes in at 3.1.
Adapting to Evolving Consumer Demand; Focusing on Reduced Risk Products: As smoking rates have started to decline in developed countries, the competition to develop alternative products is putting pressure on the tobacco industry. Serious health hazards due to smoking have pushed consumers toward low-risk, reduced risk products. After launching the much talked about iQOS, a smokeless cigarette in November 2014, Philip Morris has witnessed a steady increase in the number of iQOS purchasers. iQOS smokeless cigarette looks a lot like a second generation vaporizer that uses actual tobacco in the shape of small Marlboro cigarettes called HeatSticks that are heated at high temperatures, but not burned. The company launched iQOS in key cities in 27 markets globally during second-quarter 2017, and remains on track to expand nationally in 30 to 35 markets by the end of 2017. Also, Philip Morris further anticipates producing about 100 billion HeatSticks by 2018. The company expects both higher heated tobacco unit and iQOS device sales to drive growth in 2017.
Marketing and Technology Sharing Agreement With Altria Group: The marketing and technology sharing agreement between Philip Morris and its peer Altria Group is boosting the business of both companies. Per the agreement, Philip Morris will market Altria’s MarkTen e-cigarettes internationally and Altria will distribute two of Philip Morris’ heated tobacco products in the United States. The companies have also extended their technology sharing agreement in July 2015 to work on a joint research, development and technology-sharing framework for developing unconventional cigarettes. On Mar 31, Philip Morris applied for pre-market approval of its iQOS heated tobacco product with the U.S. Food and Drug Administration, which will be sold by Altria in U.S. If the FDA grants Philip Morris’ request it will help the companies maintain market share amid declining volume and growing awareness against tobacco products.
Strong Pricing as the Growth Driver: Philip Morris has always managed to remain afloat and generate revenues with higher cigarette pricing in the face of an unfavorable tax environment and declining cigarette volumes. Since December 2013, Philip Morris has been increasing its cigarette prices and maintained its market share. This shows its strong business model and strength of its key brands. During first-quarter 2017, Philip Morris and the other tobacco companies raised their cigarette prices in a number of markets. Though higher pricing should lead to possible decline in cigarette consumption, it is seen that smokers generally remain unaffected by price increases owing to the addictive nature of cigarettes. However, price hikes help Philip Morris maintain margins at the desired level. The company continues to expect pricing as the key growth driver in the near term.
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