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Stock Strategist

Philip Morris Fires on All Cylinders

The stock looks fairly priced, so we'd wait for a dip to invest.

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Although  Philip Morris International (PM) is our pick of the tobacco group on business quality, we think the stock is fully priced after its recent strong run. With the emergence of electronic cigarettes, Big Tobacco is entering a period of existential change, and we think the heavy lifting Philip Morris has carried out to develop and commercialize tobacco-based cigarette alternatives will give the firm a strong leadership position in the emerging e-cig categories in the medium term. We expect Philip Morris' brand equity and cost advantages, the sources of its wide economic moat, to be transferable to its heat-not-burn platforms, and we remain comfortable with our wide economic moat rating and $92 fair value estimate. Nevertheless, we urge investors not to get carried away by the attractiveness of Philip Morris' e-cig proposition, iQOS. The product is likely to cannibalize the combustible business, and we think there are risks to its superior margin profile.

There are several legitimate reasons for the recent momentum in Philip Morris' stock. First, underlying business fundamentals are strong. The company achieved above-par pricing of more than 6% in 2015, while volume declined just 1%. Although currency remains a significant drag (it reduced EBIT by 20% last year), Philip Morris gained share globally, and its 6% constant-currency revenue and 11% EBIT growth represented one of the strongest underlying performances in large-cap consumer staples. Second, rumors have resurfaced recently that Philip Morris could recombine with Altria (MO). We think this is likely in the long term: The United States remains an attractive market in terms of affordability, and it would reduce Philip Morris' significant currency exposure and unify control of the Marlboro and iQOS brands under one management. However, with the dividend payout ratio currently around 90% and with some leverage already from previous share buybacks (debt/EBITDA was 2.5 at the end of 2015), we think any transaction is unlikely in the near term.

Philip Gorham does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.