Phillip Morris' Resilient Business Model Proves Successful Once Again

Philip Morris' (PM) flexible business model has once again demonstrated its ability to generate significant results, driven by the non-elastic product category characterized by stable demand and arbitrary pricing.

Despite this, the significant international exposure of the Philip Morris Company is constrained by the potential macroeconomic and geopolitical risks of the current volatile market, as all of its cash flows come from outside the United States.

The company is currently facing two major issues: Russia's ongoing invasion of Ukraine, which has disrupted operations in the affected regions, and the fluctuation of the US dollar. As all of the company's cash flows come from currencies other than the US dollar, it is experiencing a serious foreign exchange headwind, which is putting further pressure on its highest and lowest targets.

At first glance, Philip Morris's second quarter performance may appear somewhat lackluster. However, when placed in context, we can see why the company has once again delivered a strong quarter. In the second quarter results, Philip Morris announced a net income of $7.83 billion, a 3.1% increase from the same period last year. Additionally, while shipment volume was only expected to grow by 1.1%, the actual growth rate was 3.0%.

In formal terms, the company largely excludes sales related to Russia and Ukraine in order to provide a fair annual assessment amid ongoing conflict.

The overall growth in shipments stems from a 2.4% increase in shipments of traditional cigarettes and a 7.4% increase in shipments of heated tobacco products. However, these figures require some additional context. Specifically, as anticipated in April, unit shipments of heated tobacco products in the second quarter were negatively impacted by shipping times in Japan.

Specifically, approximately two billion units are expected to be shipped in the second half of this year, as the company deals with the cancellation of its heating tobacco production plans in Russia. The current global logistics bottleneck is also another negative factor contributing to this situation. However, in the second quarter, market sales of heating tobacco units actually increased by 19.9%, even indicating an acceleration compared to the first quarter.

Interestingly, cigarette sales have increased despite a decrease in the number of smokers. This means that investors can take comfort in the fact that cigarette consumption hasn't decreased as rapidly as some may have anticipated, highlighting the continued resilience of the product category.

As previously mentioned, the company is currently being affected by strong forex headwinds due to all of its cash flow coming from outside the United States. However, its projected earnings per share, calculated with a fixed currency, are expected to increase by 5.6% year-over-year. This further demonstrates the company's ability to maintain strong profits in a high inflation environment, as demand for tobacco products is highly inelastic.

Overall, despite ongoing wars and currency headwinds, the company's performance remains consistent, to the extent that management has actually raised its outlook for the fiscal year 2022, now forecasting a constant currency EPS of $6.09 to $6.20. This means an increase of 10% to 12% from last year's $5.53.

The dividend provided by the Phillip Morris company is a vital component of its investment case, as well as a main reason why investors continue to stay committed to it despite its anti-ESG nature. Ensuring its coverage is crucial for the company. Due to the expectation of strong results, investors don't need to worry about any unfortunate circumstances.

In fact, during the post-profit earnings call, management reiterated their unwavering commitment to a progressive dividend policy and expressed anticipation that the acquisition of Swedish Match will bring additional cash flow.

Despite a recent slowdown in dividend growth rate, the recent per-share dividend growth rate is at 4.2%. However, the 5.2% yield should be enough to please income-oriented investors. With four declared dividends of $1.25, investors can expect another dividend increase in mid-September.

Additionally, with the increase in cigarette shipments, strong pricing, and satisfactory profit margins, the dividend payout ratio will further increase.

Furthermore, as tobacco sales increasingly contribute to the total revenue, profit margins continue to expand. In the 2021 fiscal year, Philip Morris' adjusted operating income profit margin increased from 29.6% to 33.2%.

According to management, the midpoint of this year's expected earnings per share will have a dividend payout ratio of 81.3%.

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