Philip Morris is a great idea for revenue growth (NYSE: PM)

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By the Valuentum team

Philip Morris International Inc. (NYSE:PM) owns several of the world’s best-selling cigarette brands, including the Marlboro, L&M, Chesterfield and Parliament brands, as well as its IQOS “smokeless” tobacco product. It sells these products outside the United States after Separate with Altria Group, Inc. (MO) in 2008. The company is using its pricing strength to offset headwinds from inflation and the secular decline in cigarette shipment volumes, to some extent supporting its cash flow outlook, as is his push towards alternative tobacco products. We are big fans of Philip Morris’ stable cash flow profile, pricing power and ongoing cost structure improvement initiatives. The company is a great revenue-generating idea with plenty of room to grow its dividend over the next few years, with PM shares earning around 5.0% at the time of this writing.

Investment Considerations

The company Goals generate more than half of its revenue from smokeless products by 2025, led by unit sales of heated tobacco. Sales of the company’s IQOS offering have grown up at a steady pace over the past few years with ample room for upside. Recently, Philip Morris used acquisitions to increase its exposure to the pharmaceutical and consumer health and wellness space. This includes the acquisition of OtiTopic, Fertin Pharma, and Vector. By 2025, Philip Morris aims to generate at least $1.0 billion in net revenue from the sale of nicotine-free products.

We don’t expect the company to alienate its income-focused investors for the foreseeable future and appreciate Philip Morris’ ‘A rating’ investment grade credit rating (A2/A/A). The firm has grown up its annual dividend from $1.84 per share in 2008 to $5.00 per share on an annualized basis currently. Going forward, we see room for further payment growth as Philip Morris forecasts that it will deliver organic revenue growth of 4% to 6% (non-GAAP adjusted figure) and currency-neutral adjusted diluted EPS growth of 8% to 11% (non-GAAP figure) this year. The company’s growth prospects are promising.

Philip Morris benefits from its exposure to faster growing regions of the world, notably Asia and EMEA. Nevertheless, it remains exposed to regulatory risk and excise price shocks that may impact tobacco demand in some countries. Currency fluctuations can sometimes weigh heavily on profits and should not be ignored. Philip Morris is reduce its activities in Russia following the Russian invasion of Ukraine and intends to exit the Russian market.

Using 2020 as a benchmark, Philip Morris aims to produce ~$2.0 billion in annualized savings by 2023 in an effort to reduce manufacturing costs and contain SG&A expenses. An improving cost structure supports the company’s outlook. In 2021, Philippe Morris spear a three-year share buyback program expected to total approximately $5.0 billion to $7.0 billion. The company is targeting a long-term dividend payout ratio of approximately 75% of its adjusted diluted EPS.

Painting by Philip Morris

Philip Morris is a rock solid company. (Valuentum Securities, with data from Philip Morris)

Economic profit analysis

The best measure of a company’s ability to create value for its shareholders is expressed by comparing its return on invested capital [‘ROIC’] with its weighted average cost of capital [‘WACC’]. The gap or difference between ROIC and WACC is called the economic profit gap of the firm. Philip Morris’ 3-year historical return on invested capital (excluding goodwill) is 116.9%, well above its cost of capital estimate of 9%.

In the next chart below, we show the likely trajectory of ROIC in the coming years based on the estimated volatility of the main drivers of the metric. The solid gray line reflects the most likely outcome, in our view (the “baseline” scenario), and represents the scenario that results in our estimate of fair value (the blue dots represent the “upside” scenario and the green dots represent the “bear” case scenario).

Graphic by Philip Morris

Philip Morris is a formidable generator of shareholder value. (Valuen Titles)

The upcoming chart below shows how we calculated Philip Morris’ estimated WACC.

Chart explaining how Valuentum Securities calculated Philip Morris

How we calculated Philip Morris’ estimated WACC. (Valuen Titles)

Cash flow and balance sheet analysis

Philip Morris is a great free cash flow generator, defining free cash flow as net operating cash flow minus capital expenditures. It is its free cash flow that allows Philip Morris to pay and sustainably increase its dividends, keeping in mind its balance sheet considerations.

From 2019 to 2021, Philip Morris generated about $9.9 billion in free cash flow per year on average, and its run rate dividend obligations were $7.6 billion last year. . Although Philip Morris has historically not repurchased significant amounts of its common stock, after launching its three-year buyback program it acquired $0.8 billion of its common stock in 2021.

However, we caution that Philip Morris had net debt of $23.3 billion at the end of December 2021. The company has ample liquidity as it exits 2021 with $4.5 billion in cash and cash equivalents on hand. to meet its short-term financing needs.

Philip Morris Map

We are big fans of Philip Morris’ stable cash flow profile. (Valuentum Securities, with data from Philip Morris)

Evaluation analysis

Our discounted cash flow process evaluates each business based on the present value of all future free cash flows. We believe Philip Morris is worth $100 per share with a fair value range of $80.00 to $120.00. Our near-term operating forecasts, including revenue and earnings, do not differ materially from consensus estimates or management guidance. Our cash flow model reflects a 3.1% compound annual growth rate in revenue over the next five years, a pace higher than the company’s historical 2% compound annual growth rate over 3 years. Our model reflects a projected 5-year average operating margin of 45.2%, which is above Philip Morris’ 3-year average. Beyond year 5, we assume that free cash flow will grow at an annual rate of 2.1% for the next 15 years and 3% in perpetuity. For Philip Morris, we use a weighted average cost of capital of 9% to discount future free cash flows.

Table of valuation assumptions used by Valuentum Securities to obtain Philip Morris

Under our base case, we assign a fair value estimate of $100 per Philip Morris share. (Valuen Titles)

The upcoming chart below provides a visual deconstruction of Philip Morris’ intrinsic value broken down by phase of the economic cycle, including its net balance sheet considerations.

Philip Morris Map

A visual deconstruction of Philip Morris’ intrinsic value by phase of the economic cycle, taking into account its net balance sheet. (Valuen Titles)

Although we estimate the fair value of Philip Morris at approximately $100 per share, each company has a range of probable fair values ​​that is created by the uncertainty of key valuation factors (such as future revenue or earnings, for example ). After all, if the future was known with certainty, we wouldn’t see much volatility in the markets because stocks would trade precisely at their known fair values.

In the next chart below, we show this likely range of fair values ​​for Philip Morris. We think the company is attractive below $80 per share (the green line), but quite expensive above $120 per share (the red line). Prices that fall along the yellow line, which includes our estimate of fair value, represent a reasonable valuation for the business, in our view.

Philip Morris Map

The upper end of our fair value estimate range is $120 per Philip Morris share. (Valuen Titles)

Final Thoughts

We’re big fans of Philip Morris’ revenue growth potential, and the company also has significant upside capital appreciation. Philip Morris’ push towards alternative tobacco and nicotine-free products as well as its cost structure improvement initiatives support its longer-term free cash flow growth prospects. To download our 16-page Philip Morris Equity Report, please click here (pdf). There’s a lot to love about Philip Morris, and we hope you’ll continue to appreciate our work.

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