It's no secret that society has slowly been snuffing out cigarette smoking as a habit. That societal trend makes tobacco companies like Philip Morris International (PM 2.82%) look like "dying" stocks to investors. An indicator of this is the fact that the stock is still trading near the same price it did in 2012.
But a new business around reduced-risk tobacco products is developing somewhat under the radar at Philip Morris International (PMI), giving the company a new shot at a bright future and investors a well-supported dividend that currently yields 5.8%.
Let's look at three reasons why this stock has some real potential at the moment.
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1. PMI stock is cheap...
PMI stock is inexpensive at a time when the broader markets continue to trade near all-time highs. The company is three quarters into its 2021 fiscal year and is guiding to finish with earnings per share between $6.01-$6.06. Using the current share price around $88, this works out to a price-to-earnings ratio of 15.4. This valuation is cheap at face value, as well as compared to its historical average P/E of 17 and the S&P 500's P/E of more than 28.
Now let's add some context. We can go back to 2012 when the stock traded at $87 per share, and the company generated $5.17 per share in earnings that year. The modest earnings growth makes the business appear stagnant, and thus the stock price has been as well.
2. ...But the business is strong
But this stagnation isn't necessarily the case. The strength of the U.S. dollar has tamped down a lot of the company's growth over the years. PMI does virtually all of its business in foreign currencies but reports in U.S. dollars.
If the dollar increases in value against foreign currencies, its foreign sales are exchanged into U.S. dollars for reporting, resulting in apparently lower revenue. We can see below that the dollar has been on a long-term uptrend since 2012.
Real Trade Weighted U.S. Dollar Index: Advanced Foreign Economies, Goods and Services data by YCharts
However, the big difference between PMI in 2012 and 2021 is the development and success of its IQOS system. It's a "reduced-risk product" (RRP) that heats the tobacco instead of burning it, which PMI claims is far less harmful to users than traditional cigarettes.
Philip Morris International first launched IQOS in Japan, its first market in 2014, and the RRP business segment now makes up 29% of PMI's total company revenue. Its RRP revenue grew 33% year over year in the third quarter of 2021, so IQOS momentum remains strong. PMI has planted its flag for IQOS being the company's future primary business driver and now actively markets itself as being part of a "smoke-free" future.
3. PMI's dividend lets investors get paid to hold
The reality for investors is that the stock has been range-bound for much of the past decade, but PMI's juicy dividend continues to increase each year and pays investors to be patient.
The dividend works out to $5 per share per year (paid quarterly as $1.25 per share) and investors get a robust 5.8% annual return on every share they own at the current share price. For a long-term investor that continually invests those dividends back into the stock to buy more shares, this can turbo-charge the compounding of dividend income over time.
Management is forecasting $11 billion in operating cash flow for the entire 2021 year, leaving $10.4 billion in free cash flow after needed investments into the business, which can be used to pay dividends.
A $5 per share annual dividend paid to 1.55 billion outstanding shares means that Philip Morris has a total dividend expense of $7.75 billion, spending 74% of its free cash flow on dividends. That free cash flow ratio is starting to get high, but investors should feel confident in the company's ability to continue to afford this payout, especially with revenue expected to grow as much as 7% this year. The tobacco business requires little spending to maintain itself to afford a higher payout ratio.
There's always a catch
PMI has a lot of attractive qualities if you're looking for a combination of steady growth and dividend income. However, no investment is "bullet-proof." The company's largest headaches will continue to center around the fluctuations of currency exchange rates.
Management expects a $0.17 boost to earnings per share due to a weaker U.S. dollar in 2021. Still, if exchange rates become unfavorable, the company could be back in the position of dealing with a strong U.S. dollar offsetting earnings growth. Still, Philip Morris has proven itself to be a resilient business, and IQOS might have the company poised for a bright future.
