Peter Lynch once said that a great company to invest in would make a product that customers have to keep buying. He went further to say if the product was addicting, that was even better. He mentioned the old Philip Morris as one of these great opportunities. Today, I’m sure Philip Morris International Inc. (NYSE:PM) would catch his eye. The things Lynch liked the most about the old school company are now almost entirely tied up in Philip Morris International. He liked that real growth was found overseas, the product is addictive, and there are less legal issues with tobacco internationally. For investors willing to overlook the potential health issues, this sounds like his definition of the perfect stock.
The Difference Between Here And Abroad
The cigarette industry in the U.S. is dominated by a few heavyweights that have well known brands. The good news for stockholders is these brands have great pricing strength, and the addictive nature of cigarettes keeps volumes from falling too quickly. Companies like Altria Group Inc (NYSE:MO), Reynolds American, Inc. (NYSE:RAI), and Lorillard Inc. (NYSE:LO) make up the domestic cigarette market. Each of these companies generate tremendous cash flow, and pays a generous dividend.
The bad news of course is that domestically there are both huge legal obligations and a tremendous amount of education and products to try and help smokers quit. In addition, the domestic cigarette market consistently posts declining volumes. Manufacturers have to either improve their margins or take market share in order to increase profits.
The international market is a different story. Overseas, there is still opportunity for real volume growth along with price improvements. While there is education about smoking’s risks, the amount of public outcry is different. This environment is what makes Philip Morris such a different investment from their peers.
One big challenge that Philip Morris International Inc. (NYSE:PM) faces is also a huge opportunity in the future. Since the company is still expanding and increasing their market share, Philip Morris operates on much smaller margins than their domestic counterparts.
In fact, in the current quarter, Reynolds American, Inc. (NYSE:RAI) led the way with an operating margin of 34.6%. Lorillard and Altria Group Inc (NYSE:MO) followed in the domestic race with margins of 30.63% and 28.28%, respectively. Philip Morris International showed an operating margin of just 17.89%. As you can see, today Philip Morris International Inc. (NYSE:PM)’s margin is greatly compressed because of expansion costs and trying to keep the costs to the consumer low. However, over time the company should be able to increase their margins to a level closer to their domestic counterparts, which would dramatically improve earnings.