One of the biggest concerns facing investors regarding the tobacco companies is falling cigarette consumption, and so they hence are skeptical to assign much if any growth to these companies. A closer look at Philip Morris International however points to a robust economic model and sound cash flow generating ability. The stock has climbed more than 12% in 2012 so far, and we believe there is more to come. Philip Morris International competes with tobacco majors like British America Tobacco and Imperial Tobacco Group, among others.
Philip Morris International logo
Tobacco companies have been raising the prices of cigarettes periodically in Europe to make up for the declining volumes. It’s easy to justify the price increases by blaming the governments and rising input costs. Moreover, the company doesn’t necessarily lose from declining cigarette volumes. Since the value of excise taxes are fixed for a pack of cigarettes (rather than a percentage of selling price), raising the selling prices increases the net revenue per cigarette pack (i.e. revenue – excise taxes) for the company. Besides, declining cigarette volumes could not stop the company from posting growth in overall net revenues. In 2011, the net revenues for the European region grew 4.6% to $9.2 billion. Even in Q1 2012, net revenues rose 2.5% y-0-y.
Philip Morris International’s ability to generate top-line growth in a region which is struggling economically and where demand for cigarettes is showing a decline says a lot about the company’s strong pricing power. Also, note the governments tend to raise excise taxes when they are struggling to meet their respective fiscal deficit targets (tobacco companies are easy targets). If and when the European economies improve, we could see excise taxes staying relatively muted. Stable excise taxes can slow down the rate of decline in cigarette consumption.
