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Philip Morris (PM) -- My Nicotine Addiction
#1
I’ve been meaning to do a more detailed post on PM for a while now, and with the share price below $85 at the moment, it seems like a good time. By any ‘typical’ measure, I’ve got way too much tobacco in my portfolio right now. MO is slightly over 10 percent of my portfolio, and PM is right about 9 percent. But I really am addicted – I can’t stop myself from accumulating more shares at these prices. Here’s why:

First off, before you call me crazy for having 20 percent or more of my portfolio in tobacco stocks, read my views on a balanced portfolio here. I am still a long way from retirement, I believe that you should go with your best ideas, and I will strive for better balance through new purchases as I approach retirement. Also, consider that MO is easily in the running as the best performing stock of the last 100 years. MO and PM sell an addictive product that is simple to make and distribute with significant pricing flexibilty. These companies have huge cash flows and are, in my mind, about as close as it gets to printing money. Talk all you want about litigation, health consciousness, and onerous regulation and legislation. These companies have thrived in the face of these same headwinds for decades.

I discussed MO in a bit more detail here, so will focus now on PM. I think they are both great buys at today’s prices, but any new money I put into tobacco is going into PM. This is because I am planning to hold these shares for decades, and I think with the entire globe at its feet, PM might have an easier time sustaining earnings and dividend growth over that time frame.

Here is how PM stacks up on the primary dividend growth metrics that I watch:

Technically, PM’s streak of raising the dividend is only 6 years long. But it has only been an independent company for that long, since it was spun off from MO. It has raised the dividend like clockwork every year since it was spun off. And in my accounting, I give it credit for a longer streak because it was a part of MO prior to the spinoff. Annual dividend raises are in PM’s DNA and I have little doubt that healthy annual raises are a top priority.

At current prices, PM’s yield is a very solid 4.4 percent. You have to look back to about the middle of 2010 for the last time PM’s initial yield was this high. Relative to the income received, PM is cheaper right now than at any time since I’ve been buying it (I bought my first shares in July of 2012). In today’s environment, I’ll take 4.4 percent happily.

PM’s payout ratio is in the mid-to-high 60s somewhere, probably around 66 percent, by my math. For a company that generates the kind of cash that PM does, this is a completely healhty and sustainable payout ratio. Compare to MO’s target payout ratio of 80 percent.

PM’s P/E ratio is in the 15 to 17 range, depending on which earnings you are looking at. Looking at PM’s historical P/E, you could have bought it at lower multiples many times since the spinoff, but it is solidly in its range for the past couple couple of years and now that it has more of an established track record, it would not surprise me if this becomes its “new normal” P/E range.

PM sports a fine five-year earnings growth number in the 11 to 13 percent range. Probably the biggest caution with PM is that the earnings growth in the most recent two years has slowed considerably, to 6.8 percent last year and – if 2013 estimates are accurate – to about 4.8 percent this year. Projections for 2014, for whatever they are worth, are more rosy (about 10 percent).

Dividend growth is solid, with a five-year average dividend growth rate of over 12 percent. PM’s recent raise was a still-very-nice 10 percent.

I am not an expert at reading and interpreting balance sheets (far from it), but there has been a lot of discussion of PM’s increasing debt load of late. As I’ve said before, this does not concern me too much, given PM’s excellent cash flow. Moreover, I think the additional debt is being used to help fund PM’s consistently aggressive share buyback program. It seems reasonable to me to borrow at 1 or 2 percent to retire shares that you would have had to pay a 4 percent dividend on.

I’d love to hear others’ thoughts about PM. Am I on target, or am I overlooking important factors?
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#2
Declining use in Europe and increasing taxes/legislation is a concern of mine. Europe is roughly 1/3 of their earnings.

I'm also concerned about the debt. Their cash flow has been dropping(yoy) and debt increasing.... not a good combo. Also once the fed starts to taper they will no longer have access to cheap borrowing which has been funding the large buybacks.


I'm hoping/kind of expecting for their next earnings to be a good one, since they raised the dividend more than expected.

As I said in the other thread I'm looking for a roughly $83 entry point. That's less than 2% from where we are today. A couple of reasons none of which are too technical:

1. My current average price is $85 and I like to average down.
2. Pm's normal historic Pe/ratio according to fast graphs is 15.2 or close to $83. I would prefer to buy it below that but it hasn't dropped below that line in 2 years, and I don't think it will go much lower since the div is so high here.
3. @ $83 pm yields 4.5%

Currently I have 5.8% of my portfolio in LO, 2.3% in PM and 1.2% in MO. So roughly 9.3% in tobacco. I'll probably double my stake in PM and not add anymore for a while. I don't want to go over 10% in tobacco.

One last thing, if they ever get into China it will be HUGE for PM. I'm not sure if that will ever happen.
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#3
I'll invest in most things, but draw the line with the cigarette death business. I'm sure many investments have similar dark sides, but with tobacco products, addiction seems the main goal, and an ugly death being an almost certainty for lifelong users. No tobacco companies for me, no matter what the returns.
Alex
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#4
Fair enough, Alex. And I know that there are plenty of people who agree with you. It is true that most companies of any size have some dark aspects to keeping the business profitable, and you’d have to avoid almost all of them if “do no harm” was a primary criteria. But it is impossible to deny that tobacco companies profit in a particularly pernicious way.
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#5
No judgement intended, just a personal decision. Have seen too many family members and friends impacted by this terrible addiction.
Alex
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#6
PM is getting hit hard today after lowering guidance for 2013 and at least one downgrade. What do you think -- great sale price, or are PM's long-term prospects looking worse? I lean toward the former.
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#7
I also lean towards the former. If it wasn't already over 8% of my portfolio, I would be buying today. Though knowing me, I might still do it.
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#8
Looking to add PM today, hopefully I get filled @ 86.00 for initial yield of 4.37%.

Good luck to all.
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#9
(11-26-2013, 07:21 AM)NilesMike Wrote: Looking to add PM today, hopefully I get filled @ 86.00 for initial yield of 4.37%.

Good luck to all.

Do you see any short term catalysts that will cause PM not to continue falling? It's definitely getting into the "value range" but I feel like it will continue to go lower, since there are no positive catalysts short term that I have seen.
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#10
(11-26-2013, 11:30 AM)fiveoh Wrote:
(11-26-2013, 07:21 AM)NilesMike Wrote: Looking to add PM today, hopefully I get filled @ 86.00 for initial yield of 4.37%.

Good luck to all.

Do you see any short term catalysts that will cause PM not to continue falling? It's definitely getting into the "value range" but I feel like it will continue to go lower, since there are no positive catalysts short term that I have seen.

I agree. I don't see any catalysts in the near term, especially after reading their recent comments about currency headwinds. I'm still long and will be reinvesting dividends, but don't plan on adding any new capital. I think PM could be dead money for the next 12-18 months.

Still a great long term hold, but shorter term there are much better options out there.
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#11
I agree that it could drift lower from here, but I am not positive either way. The recent negatives may set very low expectations going forward, such that even neutral to slightly positive news could provide catalyst for a bounce.

That said, this episode may well test whether PM has deserved or will maintain the premium that it has enjoyed in the past over its tobacco company peers.

NilesMike -- looks like you should have had no trouble getting filled at $86, as the price even made it below $85 today. Since then it has been working its way back up and is now down less than half a percent on the day. I'm definitely interested in PM at prices below $86, but I already own quite a bit of it. If prices do go lower, though, I may feel compelled to add. I still count the tobacco stocks as some of the safest dividend growth stocks for the long term.
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#12
(11-26-2013, 01:32 PM)TomK Wrote: I agree that it could drift lower from here, but I am not positive either way. The recent negatives may set very low expectations going forward, such that even neutral to slightly positive news could provide catalyst for a bounce.

That said, this episode may well test whether PM has deserved or will maintain the premium that it has enjoyed in the past over its tobacco company peers.

NilesMike -- looks like you should have had no trouble getting filled at $86, as the price even made it below $85 today. Since then it has been working its way back up and is now down less than half a percent on the day. I'm definitely interested in PM at prices below $86, but I already own quite a bit of it. If prices do go lower, though, I may feel compelled to add. I still count the tobacco stocks as some of the safest dividend growth stocks for the long term.

I did get filled at 86. (Just checked, filled at 85.48) I have no crystal ball showing a short term catalyst, it's in the shop!

This is a decade long play for me, it is a good yield and should work out long term.
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