The terms of Philip Morris International’s spinoff from Altria in 2008 made it a company with characteristics that are, to my knowledge, unmatched by any other large-cap stock. And it is that Philip Morris International is a company that sells essentially the same cigarette brands that Altria sells to investors in the United States, except 0% of Philip Morris International’s revenues are generated by selling cigarettes to American investors. It’s all overseas money, except Philip Morris International keeps its headquarters on Park Avenue in New York and reports all of its profits, volumes, and balance sheet considerations in numbers that are converted to U.S. dollars.
This has two implications for those who study the stock:
First, I’ll state the conclusion. Philip Morris International benefits when the dollar declines against the rest of the world’s currencies, as earnings become stronger than actual performance during that point in the currency cycle. The reverse is also true: When the U.S. dollar performs strongly against the rest of the world, Philip Morris International gives reports that are weaker than its actual business performance would suggest if we lived in a world that was united by a single form of currency.
To get more specific on that point, Philip Morris International makes 30% of its profits in countries that use the Euro, and 27% of the profits come from Eastern European and Middle Eastern countries that have seen the strength of their currency slide along with the decrease in oil (interestingly enough, this is the kind of correlated risk analysis that very few financial professionals provide: if someone owns, say, Philip Morris International and BP, they might walk away thinking they are diversified because oil and tobacco are two very different businesses. But yet, Philip Morris relies on Russia and Eastern Europe, and BP relies for 20% of its profits from Russia, and a slide in Russia’s oil fortunes mean lower profits for BP and a tougher go-of-it for Philip Morris International as the U.S. dollar would likely appreciate against countries with economies dependent on oil exports).
But to finish that thought—Philip Morris International generates 57% of its profits in Euro and oil-backed economies which have performed poorly against the U.S. dollar, making Philip Morris International’s results appear weaker than a constant-currency comparison would indicate. According to the most recent release, Philip Morris profits were sharply affected by currency translations to the tune of $0.65 in the past year.
After hitting a high of $94 in 2012 and $96 in 2013, the price of the international tobacco giant’s stock has come down to $83 per share. That is because Wall Street has been reacting negatively to declining earnings: profits of $5.26 in 2013 became $4.85 in 2014 and are only expected to trickle a little bit higher this year when taking into account the effects of the U.S. Dollar’s relative strength. What is worth mentioning though is this: On a true business study of Philip Morris International, it is as if profits grew from $4.85 in 2013 to $5.50 in 2014. The current 80% dividend payout ratio seems high because the company does have to deal with the dollar’s strength when it cuts dividend checks to shareholders (the significant 83% majority of which are in the United States), but these things ebb and flow quickly.
When oil rebounds driving up Russia and Eastern European currencies, or when the Euro performs strongly, suddenly Philip Morris International’s profits pop. We saw this from 2009 to 2011 as profits quickly grew from $3.24 to $4.85, and despite raising the dividend from $2.24 to $2.82, the dividend payout ratio came down from 68% to 56%. Philip Morris now sells 40% of the cigarettes purchased in the European Union, up from 24% a decade ago. Conversely, this increased reliance on the E.U. leads to lower reported short-term profits.
And secondly, I am writing this because you need to come up with a model that recognizes Philip Morris International is slightly cheap at $83 in 2015 with its 4.8% dividend yield. Sure, a stock screener may show $4.85 in profits and a P/E ratio of 17 that makes the company look like it is on the high side of fair value, but the stock is trading at around 15x earnings on a currency-neutral basis. In years like 2009, 2010, and 2011, you need to discount the important of the P/E ratio because it makes Philip Morris International appear cheaper it actually is. In years like 2014 and 2015, you should discount the importance because it makes Philip Morris International appear more expensive than it actually is. You need to borrow liberally from the cyclical oil stock investing toolkit that teaches about P/E traps and how oil stocks tend to be cheapest when their P/E ratio is the highest and vice versa because of the spring forward, pull backward nature of their profits over the course of a business cycle. Although not quite a cyclical, this principles of cyclical valuation models apply to studying a unique company like Philip Morris International that reports in U.S. dollars while generating none of its profits here.