Philip Morris International Inc. (PM, Financial) released a stellar second-quarter earnings report on Thursday, which led to a surge in its stock price. The world's largest tobacco company beat its revenue target by $290 million and trumped its earnings per share estimate by 12 cents, suggesting that market analysts underappreciated its resilience against a shaky economy.
With the tobacco giant's second-quarter earnings report in arrears, the questions beckons: Will the company sustain its robust results, and how will it impact its stock price? Let's delve into a deeper discussion about Philip Morris International's latest endeavors to find out.
Understanding the earnings report
Philip Morris reported significant momentum from key segments during its second quarter. First, the company's broad-based shipments increased by 3.3% year over year, while its revenue per unit increased by 7.7%, illustrating a secular sales pattern instead of cyclical demand.
As anticipated, the company's heated tobacco products gained additional traction. The segment's shipment volumes surged by 26.65 year over year, concurrently playing a pivotal part in Philip Morris' transition toward a non-combustible business model. In fact, the segment's latest results mean its shipment volume now spans approximately 16.4% of the company's total demand.
Progress with smoke-free products
Further, Philip Morris' progress with smoke-free products is overlooked. The segment comprises approximately 35% of the company's revenue mix and is exposed to an industry with a compound annual growth rate potential of 14.6% until 2033.
Source: Future Market Insights
Role of combustible products
Although Philip Morris' newer products have recently drawn much attention from investors, its combustible products should not be overlooked. In fact, its Marlboro brand has received three price hikes in the U.S. during the past six months, illustrating why the combustibles division has a 23.9% market share. Moreover, combustible sales diversify the company's target market, lending it the opportunity for cross-sales and lower income statement variance.
Operating margins and profitability
Philip Morris' operating margin remains robust despite rising input costs around the globe. The company's gross profit margin of 64.2% is accommodated by a cyclical average net profit margin of 26.41%, illustrating the quantity of residual value being passed through to its shareholders.
Key operating metrics
In my view, the salient features of a business' efficiency can be measured by three ratios, namely the cash conversion cycle, asset turnover ratio and the inventory turnover ratio. Philip Morris' cash conversion cycle is trending downward, suggesting the time between buying and converting inventory into cash is receding. The introduction of artificial intelligence-driven supply chain solutions might proliferate this metric even further in the coming years, resulting in an improved income statement.
The asset turnover ratio is another operating metric that provides substantial insight into a company's operations. Philip Morris' asset turnover ratio presents a few worries, as its downtrend suggests receding monetization of its asset base. Much of this might be due to excess acquisitions, often resulting in goodwill that cannot be monetized. Additionally, Philip Morris' non-combustible products segment possesses intangible work-in-progress assets.
Although a risk, I believe the company's receding asset turnover ratio can be justified. Finally, its inventory turnover ratio is trending upward. As mentioned earlier, the company's profit margins are robust, suggesting it does not suffer from a poor cost structure. As such, the ratio's uptrend is likely due to lower inventory stockpiles, implying efficient inventory management.
Valuation and dividend prospects
My choice of valuation method includes a forward-looking approach that utilizes Philip Morris' earnings per share guidance and a relative comparison of its stock's past price-earnings ratios. Philip Morris International's expected earnings for 2023 is between $6.13 to $6.22 per share. If the Friday pre-market stock price of $98.18 is divided by the midpoint EPS figure, a forward price-earnings ratio of 15.88 is conceived.
A price-earnings ratio of 15.88 is below Philip Morris' cyclical averaged ratio of 17.01, suggesting that its stock has value in store.
The second component of its expected return is its dividend—the company's five-year average dividend yield on cost of 6.1% illustrates the risk-return benefits its stock presents as it aligns with the "bird in hand" theory, which says that investors assign lower risk to income-generating assets.
Potential risks
Philip Morris' identifiable risks are relatively straightforward.
First, the company is in the midst of a transition to satisfy a new consumer base, which presents costly restructuring charges. Further, its combustible products segment faces elevated environmental, social and governance risk premiums, potentially assigning a lower terminal value to the business.
Conclusion
Philip Morris' second-quarter earnings release has again shown why its stock presents compelling total return prospects.
The company's non-combustible products segment is garnering momentum, while its combustible division continues to enhance its market share. Further, Philip Morris' efficiency metrics are well aligned and its valuation multiples, coupled with its dividend profile, suggest there is value in store.
