Last week, I discussed the implications of Philip Morris (PM) reducing its short-term expectations for 2014, which the company stated would be an investment year. Philip Morris will look to launch a new series of products into 2015, and the company stated that the investment year would hurt short-term results. Philip Morris shares pulled back a few dollars on the news, and I said that it probably was best to wait for a lower entry point. Well, that opportunity may have come the following day, after an analyst downgrade took a chunk out of the stock. Today, I'm going to circle back to Philip Morris. I want to look at the analyst downgrade, where expectations stand now, and see what the best course of action is for investors.
The Goldman Sachs downgrade:
The day after Philip Morris gave its weak 2014 forecast, Goldman Sachs was quick to downgrade the cigarette giant. The firm removed Philip Morris from its Conviction Buy list, lowering its rating to Neutral, and cutting the price target from $103 to $95 (which still represents decide upside for a name like this). Additionally, GS cut its earnings estimates on Philip Morris by 4%-6% for 2014 through 2016. Analyst Judy Hong stated the following:
"Weaker end market demand and higher investment needs drive our rating downgrade, and we have lowered our 12-month P/E-based price target to $95 from $103 as we incorporate the lower estimates and a lower multiple (16.0X from 16.5X), the latter of which is driven by a murkier near-term outlook."
Now this was just one analyst's opinion. You also should know that this was the same analyst who downgraded PM to Neutral early in 2012, right before the stock's big jump. So was this a signal to buy? Some might argue that it was.
The analyst's comments did have a big impact on shares of Philip Morris. Philip Morris shares closed Wednesday at $89.30, down two and a half bucks from the day's high thanks to the weak 2014 guidance. On Thursday, shares opened lower and dropped to a low of $84.90 on the day. At that low, Philip Morris was down more than $4, a fall that's very uncommon for this name. Shares did recover a bit by the close, but at Friday's close of $86.95 were still $2.35 off Wednesday's close. In total, Philip Morris shares pulled back 5.3% from Wednesday's high. I do think the initial selloff to below $85 was overdone, but could I see that level being reached again shortly? Let's now look at where Philip Morris stands in regards to others in this space.
How expectations have come down:
While the Goldman Sachs analyst seems like the only one so far to have a formal note out on PM, overall estimates are coming down. Going into Wednesday, the average 2014 revenue estimate for Philip Morris was $32.34 billion. That was for 3.5% growth, based on the estimate at that time for 2013 revenues. Remember, until we get the actual full year numbers, the 2014 growth number you see from analysts could vary at the same dollar level since the 2013 level (the base number) can still change. Current estimates call for $31.91 billion in 2014, or 2.1% growth. That's a decrease of more than $400 million in revenues, and about two-fifths of the growth number. On an earnings per share front, the average is down from $5.89 to $5.75.
Don't forget, expectations have been coming down for most of 2013, and that continued after a so-so Q3 earnings report. Back in April, when Philip Morris reported its first quarter results, the average revenue estimate for 2014 was $34.25 billion. That represented 5.8% growth on top of 3.2% growth that was expected for 2013. Currently, analysts are looking for a 0.4% decrease this year. Back in April, the average earnings per share number was $6.36. Philip Morris has been hit by a couple of items, most notably currency issues. However, cigarette shipment volumes have also hurt, so if you're not generating the revenues you were expected to, you'll have some bottom line troubles as well.
Current expectations:
When comparing Philip Morris to others in the space, I look at three other names: Lorillard (LO), Altria (MO), and Reynolds American (RAI). The following table is one I've used in several articles for this industry. It shows the currently expected growth in terms of both earnings per share and revenues. These are the analyst estimates for 2013 and 2014, as well as a two-year total. I've also provided each company's dividend yield as another way to compare these names. The yellow highlight indicates the leader in that specific category.
I've already discussed how Philip Morris' expectations have come down, and I mentioned in my last article how Lorillard's dividend yield is now less than that of Philip Morris. As I mentioned in another article for the space, the only change above (non-PM) is that Reynolds American has seen its 2014 EPS estimate raised by a penny. You can view my last update here.
What are some key takeaways here? Well, the first obvious one is that Lorillard continues to show the most growth potential. Lorillard's hold on number one got even greater with Philip Morris expectations coming down. Philip Morris is expected to have the second highest revenue growth figure in 2014, although not by much anymore. We're only a few more analyst reductions from Philip Morris' 2014 revenue growth being similar to that of Altria and Reynolds. In terms of earnings per share growth, Philip Morris is now only supposed to show the 3rd most growth, and barely above Reynolds' fourth place number. Remember, Philip Morris guided to 6% to 8% currency neutral earnings growth in 2014, below its historical target of 10% to 12%. The question now is how does Philip Morris' valuation stack up? I'll cover that next.
Current valuations:
You could have the greatest company on earth, with great growth, dividends, buybacks, etc., but that doesn't mean it will be the best investment. Sometimes, it all comes down to valuations. If that "greatest company" is just too expensive, it might not be worth it. As those who follow me know, Philip Morris' valuation against the rest of these names is one item I've tracked extensively in the past. The following table shows valuation metrics for each company in this article, as of my last update and now.
Since my last update, Philip Morris has seen its valuation drop a bit. While expectations are down, stock price is off a bit further. Lorillard continues to see its stock rise towards new highs, and the other two names have been mostly flat.
Anyone that has read my continuous coverage of Philip Morris knows that PM shares trade at a premium. Investors have been willing to pay for the solid amount of growth and the sizable buyback. I've continued to track that premium, on both a price-to-sales and price-to-earnings basis, with the results found below (compared to my last update).
I don't have the time to confirm this 100% since I write about Philip Morris often, but I believe that the current premiums are the lowest I've seen since I started covering PM heavily two years ago. On a price to earnings basis, you are barely paying any premium at all. Why does this premium still exist? Well, investors have been willing to pay up for Philip Morris' large buyback. Even though results have not been spectacular and Philip Morris stock has underperformed, a premium does still exist. However, we've seen that premium come down as Philip Morris' results have disappointed. That process could continue into 2014.
Overall analyst opinions:
I always like to look at what the professional Wall Street analysts think when it comes to the names in this space. The following table shows the average analyst rating, where a 1.0 is a strong buy and a 3.0 is a hold. The table also shows the average, or mean, price target currently, and the upside to that target from Friday's close.
Since my last update, none of the ratings have changed. Lorillard's average price target has not changed, and Altria's is up by 9 cents. Reynolds' average target is up by 78 cents, and Philip Morris has seen its reduced by $1.13. Philip Morris, as in most updates, has the most upside to the average target.
Final thoughts:
Philip Morris fell further after an analyst downgrade, and that initial selloff seems to be overdone. Shares have recovered a bit, but analyst estimates are coming down, and the stock still trades at a premium, despite very low growth projections. Philip Morris is not the growth favorite it used to be, which is why shares have underperformed lately. If we get some more negative analyst notes, I would not be surprised if shares did pull back a little more. The ideal buying point is $83.56, where the annual dividend yield hits 4.50%. For Philip Morris shares to gain traction again, the company will have to deliver with its results, something that has not happened a lot recently.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. (More...)
Additional disclosure: Investors are always reminded that before making any investment, you should do your own proper due diligence on any name directly or indirectly mentioned in this article. Investors should also consider seeking advice from a broker or financial adviser before making any investment decisions. Any material in this article should be considered general information, and not relied on as a formal investment recommendation.
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