Philip Morris International Inc. (PM): Analysts Are Expecting Too Much

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Being a stock analyst has to be one of the hardest jobs in the world.

When companies match your estimates, in large part the stock market yawns in response. When companies miss estimates, you get chided for being wrong. If a company beats estimates, you get in trouble for not knowing the company would do better. That being said, in the case of Philip Morris International Inc. (NYSE:PM), analysts have been calling for around 11% Earnings Per Share (EPS) growth for a while, and the company’s results suggest this guess is too high.

This is not As Big Of A Problem As You Think

I’m sure many investors in Philip Morris think that once the troubles in the European Union start to fade that their stock will explode. While it’s true that these issues are not helping matters, it probably won’t do as much for the company as some would think.

Philip Morris International Inc. (NYSE:PM)In a strange way, the domestic tobacco producers have already experienced what Philip Morris International Inc. (NYSE:PM) is dealing with. Domestic producers like Altria Group Inc (NYSE:MO), Lorillard Inc. (NYSE:LO), and Reynolds American, Inc. (NYSE:RAI), all had to face major economic headwinds domestically over the last several years. These companies saw smokers decline not only from the health related concerns, but also from economic forces.

Now that the domestic economy is doing better, these same companies are beginning to see revenue growth in spots. For instance, Lorillard Inc. (NYSE:LO) saw revenue growth of 3.3% in the last three months, but Altria and Reynolds American still saw declines of 2.1% and 2.6% respectively. Just for comparison, Philip Morris International Inc. (NYSE:PM) saw revenue increase by 3.2%. Revenue growth would have come in higher without a 5.4% decline in the European Union territory, but at about 26% of total revenue, even positive sales growth wouldn’t be a massive difference maker.

Even if we assume 5% revenue growth for the European Union, the company’s total weighted average for revenue growth would only go from about 3.5% to 6.2%. While this sounds like a huge improvement, this also assumes that the company’s Eastern Europe, Middle East, and Africa segment continues to report better than 10% revenue growth. In addition, all of these numbers are excluding currency changes, so real revenue growth would likely be less.

I Know It Sounds Good

Some readers are thinking, if Philip Morris International Inc. (NYSE:PM) produces 6.2% revenue growth overall, then how can you question an 11% EPS growth rate? Given that the company turned 3.2% revenue growth into EPS growth of 8.8%, I understand the confusion. The assumption would be that with greater sales growth, Philip Morris could cut costs and increase profits.

This sounds good, but the company has two major issues working against this theory. First, the company routinely has the lowest gross margin among their peers. In the last three months, Philip Morris’ gross margin was just 27.5%. When you compare this result to the 63% margin at Reynolds American, Inc. (NYSE:RAI), the 45% margin at Lorillard, or the 48% margin at Altria, you can see Philip Morris doesn’t carry the same pricing power as its domestic counterparts.

The second issue is, Philip Morris International Inc. (NYSE:PM) is already one of the most efficient operators when it comes to selling, general, and administrative expenses. The company’s SG&A expense was just 8.76% of revenue in the last three months. By comparison, only Altria Group Inc (NYSE:MO) was more efficient, with SG&A using just 8.36% of revenue. When you look at Lorillard’s SG&A expense of 9.64%, or Reynolds American’s 15.99%, Philip Morris looks extremely efficient already. The simple fact is, the company can’t cut much from its spending to raise earnings growth.

The Company’s Financials Don’t Look Great Either

The other issue with the idea that Philip Morris International Inc. (NYSE:PM) can produce 11% EPS growth is, the company’s financials have taken a hit while the troubles in the European Union have persisted. Philip Morris retired 4.25% of their diluted shares in the last year. Their peers retired between 1.5% and 4.17%. If the company can continue this torrid pace, this would seem to argue for better returns in the future.

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