Philip Morris: A Decade's Review And Concerns

Philip Morris International Inc. (NYSE:PM) has long been part of my portfolio but my memory is failing me now as to whether I got into it before or after I bought shares in Altria Group, Inc. (MO). My reasoning for owning shares in both being the following:

• Altria Group, Inc. will provide me higher but a slow growing income.
• Philip Morris International will provide me growth & faster income growth (meaning dividend growth) with its broader reach.
• Their rich history together as the previous "Philip Morris" would likely ensure both continue paying dividends through thick and thin.

While I don't have the exact dates in mind, I am certain both have been in my portfolio for a decade plus at this point and the earliest price range I recall buying is reflected in the charts below: sometime towards the end of 2011, with PM stock trading in mid $60s and MO stock trading in late $20s. Hence, this article will be referencing to their performances since October 2011.

Before we look into at the results, a few disclaimers:

• Even though I bought both stocks initially around the same time, I've been adding more of Altria Group than Philip Morris International over the years. I cannot pinpoint specific reasons other than perhaps Altria's higher yield and I often felt like the stock was treated unfairly.
• Please note that while I've added to and trimmed both stocks at various points in the last decade, the results below are for the same starting (October 2011) and end points (today).
• I am not including the impact of reinvested dividends, which would actually strengthen my thesis below.

How have both stocks fared for me in a decade?

• Let's start with the good news for both stocks: both have so far fulfilled my expectations around their rich dividend lineage. Not only have both paid dividends but also raised them every single year since 2011 so far. Altria's quarterly dividend has gone up from 41 cents/share to 94 cents/share with an increase almost guaranteed in August. Philip Morris' quarterly dividend has gone up from 77 cents/share to $1.27/share.
• Backtracking these numbers, it appears like Altria yielded about 6% during my purchase with an annual dividend of $1.64 and stock price of $27.50. Philip Morris' yield was around 4.70% based on an annual dividend of $3.08 and a stock price of $65. So, clearly, from an income perspective, Altria had an upper-hand already and this was by design as Altria was expected to be the slow grower (both in terms of capital and dividend).
• But looking at the results so far, Altria's quarterly dividend has more than doubled from 41 cents to 94 cents. A 130% growth. Philip Morris' dividend has gone up an impressive 65% but pales in comparison as it is exactly half that of Altria's.
• And what about capital appreciation? Altria is currently trading at $46.40, which means the stock has gone up nearly 70% since my initial purchase in October 2011. Philip Morris, the one expected to be the growth stock, has gone up 47% from $65 to $95.65.
• I love both Tennis and Wrestling. So, in a nod to both, I gladly declare, "Game, Set, and Match: Altria Group, Inc." or "Ladies and Gentleman, your winner by submission, Altria Group, Inc."

Why this surprise?

First, let's look at a few reasons why I believe Altria Group has thumped its much younger and supposedly more energetic sister company.

• Expectations: As I write this, Altria Group's stock is trading at a forward multiple of 9 while Philip Morris International is trading at a forward multiple of 15. Altria has traded at such low valuations many times in the past that its yield and multiple were the same. The fact that this company is under two major threats constantly (a) shrinking volume in the US (b) regulatory overhangs.
• Altria's pricing power and operational discipline are second to none. Philip Morris International has much higher costs to operate internationally and international consumers have more options than US consumers, many among who have not heard of any brand except the Marlboro man.
• Currency fluctuations are not in PM's control but have constantly been an issue for the company's numbers. Most of the currencies are almost always weak compared to the US Dollar and this affects PM's numbers adversely.

Philip Morris International Outlook

• Philp Morris recently reported a mixed quarter, with revenue being up only 3%. However, one thing still in favor of Philip Morris International is the higher growth rate. The company's earnings are expected to grow at 7.50%/yr over the next five years, which trumps Altria's expected ~4%.
• I am concerned that 7 out of the last 8 dividend increases from the company have been below 5% and I fully expect this trend to continue when the company announces its dividend increase later this year. Why? Let's look at some numbers:
  • PM has 1.55 billion shares outstanding.
  • The company currently pays a quarterly dividend of $1.27/share, which means it needs $1.96 billion in Free Cash Flow ("FCF") to at least cover its dividend commitment.
  • PM's average quarterly FCF over the last 5 years stands at $2.25 billion, representing a payout ratio of 87% based on FCF.
• Finally, from a technical perspective, PM stock is establishing a strong base in the mid to late $90s as shown by the moving averages below. The stock's Relative Strength Index ("RSI") is now at 31, suggesting it is extremely oversold and a bounce may be imminent.

Conclusion

As the meme kids of today will endorse, I was tempted to include a picture that shows "Reality" vs "Expectations" as I looked back on a decade's performance of these two stocks. While I intend to stay with Philip Morris International for a very long time, I cannot mince words about my (relative) disappointment in my returns so far. I am not adding new money into Philip Morris here and will wait for at least 6% yield before doing so.