The Gap Between Altria and Philip Morris International

The United States dollar is performing exceptionally well against the Euro and Japanese Yen in particular, and other global currencies in general, as unease about Greece and other maladies throughout the rest of the world has pushed the U.S. dollar to highs not seen since the aftermath of the 9/11 terrorist attacks. A result is that there are huge disparities in the earnings per share figures of certain companies, depending on whether or not they generate a significant percentage of profits overseas.

Take something like Altria, for example. All of its profits are generated in U.S. dollars. That was part of the terms of the Philip Morris International spinoff in 2008. Altria owns a 27.3% stake in SABMiller, and the beer giant generates profits across the globe, although the payment to Altria is largely unaffected by currency fluctuations on this (it would amount to less than $50 million per year on an ongoing basis.)

When you see that Altria is on pace to make $2.70 per share in profits this year, what you see is what you get. That is an accurate reflection of the fundamentals at the company. The current price of $51 per share puts the valuation at 19x the estimated earnings for 2015.

I think that is on the high side. After getting ungodly cheap during the litigation and master settlement years–seriously, the old Philip Morris traded at 7x earnings in 2000, so that an investor that got into the stock back then would be collecting a 22% yield-on-cost from Altria, plus you’d have shares of Philip Morris International, Mondelez, and Kraft-Heinz.

But in the days since then, Altria has typically traded at a valuation of 13-16x earnings. I find that historical valuation a fair risk-adjusted marking, because Altria should trade at a lower P/E ratio than something like Colgate-Palmolive. The market for the current offering of Altria’s products shrinks by 3.5% per year, while Colgate’s potential market grows by 2.5% in the United States and almost 4% globally. That needs to be reflected in the valuation–taxes and prohibitions on smoking are on the risk, and fewer people are doing it, and so the stock shouldn’t get valued like it’s Procter & Gamble.

The reason why Altria has historically done so well is that buying a stock at 13x earnings that grows at 8-10% and pays a 6% dividend works out really well when you reinvest. When the valuation is 19x earnings and the dividend yield is 4%, you are losing a significant part of what made the stock such a strong performer in the first place.

Compare the Altria situation to the present circumstances at Philip Morris International. Since the 2008 spinoff, cigarette shipments have actually increased slightly. You have countries like the Philippines where only out of every ten women will marry a man who is not a smoker on his wedding day. Even after marriage, six out of ten Filipino men continue smoking. Philip Morris makes money in all these countries–just about everywhere except the United States–where the cultural norms and regulations are significantly more lax than the United States. Although certain developed countries, notably England and Australia, have become stringent, the general market for Philip Morris International is much looser from a regulatory standpoint.

And because Philip Morris International makes all of its profits outside the United States, it is 100% subject to exchange effects when euros, pounds, rubles, and yen are converted into U.S. dollars. People see thc $4 dividend payment and the $4.40 in reported profits and get worried, or they look to the $82 per share price tag and conclude that the stock might be overvalued because it is trading at 19x earnings.

But the 19x earnings valuation that you see with Philip Morris International is not identical to the 19x earnings valuation that you see with Altria. If you adjust for the negative effects of the currency translation, Philip Morris International is really making $5.50 per share in profits. That’s a “real” dividend payout ratio of 72% rather than 90%, and the P/E ratio is 14.9x earnings. Rather than being overpriced, the current valuation of the stock is at that place where you’re getting a fair deal.

Any way I run the numbers, Philip Morris International should outperform Altria in the coming years. It has a higher earnings per share growth rate. Its core market has slowly expanded, while Altria’s continues to contract. It is trading at a more favorable valuation once you adjust for the currency effects. It has less regulatory and social encumbrances on its business model. The payout ratio is lower on a currency-adjusted basis. And the dividend yield is higher. It’s a classic example of reported numbers telling a different story than actual economic reality.