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3 Reasons Why This Tobacco Giant Is a Smoking Hot Buy

As the Oracle of Omaha, Warren Buffett's first rule in investing is to never lose money, and rule No. 2 is to never forget rule No. 1. For investors who take this advice to heart, the best way to minimize your risks of losing money in investing is to buy stocks whose business model you understand -- at or below fair value.

One company with a business model that is easy to understand is the large-cap tobacco stock Philip Morris International (NYSE: PM). Let's dig into the three reasons why I believe Philip Morris International is a buy for investors who don't have ethical concerns related to tobacco investing.

Image source: Getty Images.

Non-combustible products are driving volume growth

While Philip Morris International's cigarette or combustible volumes have declined year to date, volume growth of its non-combustible products led by IQOS has propelled total volume growth. Despite a 1.6% year-to-date decline in cigarette volumes, a 27.9% increase in heated-tobacco units has more than offset declines in the legacy business. This is what led Philip Morris International's total volumes to increase 1.5% year to date to 536.1 billion units.

Since Philip Morris International launched its non-combustible IQOS brand in Japan and Italy seven years ago this month, the widespread adoption of the product has been nothing short of spectacular.

For instance, the number of IQOS users surged 15.9% from 17.6 million at the end of last year to 20.4 million as of the third quarter of this year. This is well ahead of British American Tobacco's (NYSE: BTI) 16.1 million non-combustible users as of a few months ago, which makes Philip Morris International the global leader in the future of nicotine delivery.

Philip Morris International is focused on growing its sales mix of the higher-margin smoke-free products from 28.6% year to date to more than 50% by 2025. This is precisely why analysts are forecasting 12% annual non-GAAP earnings per share (EPS) growth over the next five years.

A strong and improving balance sheet

Philip Morris International's healthy operating fundamentals are encouraging. But can the same thing be said of the company's balance sheet?

Philip Morris International's net debt to earnings before interest, taxes, depreciation, and amortization (EBITDA) ratio has fallen significantly from 1.93 at the end of last year ($24.26 billion in net debt divided by $12.58 billion in trailing-12-months adjusted EBITDA) to 1.73 as of the third quarter of this year ($24.61 billion in net debt divided by $14.24 billion in trailing-12-months adjusted EBITDA).

If the company chose to use its adjusted EBITDA solely for debt repayment, it could now repay its debt in about 21 months compared to 23 months at the end of last year. Philip Morris International will likely continue paying a generous dividend to shareholders, so it won't actually be able to pay off all of its debt this quickly. But the basic takeaway is that Philip Morris International is more easily able to shoulder the burden of its debt now than it was at the end of last year, which is a positive.

Since no one metric is capable of telling a complete story, let's also take a look at Philip Morris International's interest coverage ratio. The interest coverage ratio is a measure of a company's solvency or ability to pay its interest expenses from earnings before interest and taxes (EBIT).

Philip Morris International's interest coverage ratio improved from an already robust 19.2 in the first nine months of last year ($8.70 billion in EBIT/$454 million in interest costs) to 20.6 year to date ($9.95 billion in EBIT/$482 million in interest expenses).

Based on these debt and solvency metrics, Philip Morris International is at minimal risk of collapsing under the weight of its debt.

All at an attractive valuation for the long term

Despite Philip Morris International's promising outlook for the future and manageable debt load, the stock appears to still be offering investors a good buying opportunity for the long haul. This is supported by the fact that at $94 a share, Philip Morris International's trailing-12-months price-to-free cash flow ratio of 14 is well below its 13-year median of 17.2.

Income investors looking to lock in a relatively safe high-yielding stock for their portfolio would be wise to consider buying Philip Morris International's market-crushing 5.3% dividend yield, which is quadruple the S&P 500's 1.3%. This sizzling yield is also well-covered by a payout ratio that should be in the low-80% range based on Philip Morris International's non-GAAP EPS guidance for this year.

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Kody Kester owns shares of Philip Morris International. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.


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