Player Avatar 20Punches (45.46) Submitted: 4/1/2014 3:33:06 PM : Outperform Start Price: $80.12 PM Score: -5.33

Punch #10 - Q12014 – will be Phillip Morris International (PM)

“I'll tell you why I like the cigarette business. It costs a penny to make. Sell it for a dollar. It's addictive. And there's fantastic brand loyalty.” – Warren Buffett

Phillip Morris International sells Malboro, and other brands, in all available markets outside of the U.S. The old Phillip Morris (before the MO and PM split) was (I’m fairly certain) the most profitable stock of the 20th century.

The industry has gotten a lot of negative press (even moreso than usual for the tobacco industry) due to increased anti-tobacco activism. These issues are nothing new for PM, and the tobacco company shareholder *should* continue thrive for at least another generation or two, in my opinion. As the industry slowly declines, PM’s dominant position will probably continue to widen. It’s extremely unlikely that any new, meaningful competitors will enter this industry, and PM stands poised to swallow up smaller competitors as the industry slowly declines. It may seem odd, but PM’s moat is actually strengthened by a slowly declining industry. (See Bruce Greenwald’s book “Competition Demystified” for more on that phenomenon) These recent sell ratings, general tobacco pessimism, and PM’s relatively poor stock performance (PM has been flat while that market is up over 35% over the past 20+ months) are all BUY signals, in my view.

While overall volumes will surely decrease overtime, price increases should be more than able to compensate, so revenue should remain pretty steady for the foreseeable future. Any tax increases imposed can be easily passed down to the customer as well. Virtually no business has pricing power as extreme as PM does. Also, they operates in so many countries, that it is pretty well diversified from individual regulation. The economics of PM are so insanely good, that per-share profits should continue to increase for the foreseeable future, albeit much more slowly than they have in the past. Also, don’t forget that tobacco companies provide A LOT of tax revenue to the countries they operate in, and most governments really need revenue right now. It is not in any governments economic interest to make smoking illegal.

Consider this scenario: if net income grows at just 4% per annum over the next 5 years, and buybacks continue at 4% of shares outstanding per annum – both reasonable assumptions - than EPS will grow to around $7.83 over the next 5 years. Put a reasonable 15x multiple on that, you get a share price around $117 in 5 years. If you put a conservative 4% per annum growth rate on the dividend as well, PM will pay you about $20 in dividends over the next 5 years. $117 + 20 = $137 total return, which from today’s price of $81.92, translates into a 10.8% annualized total return.

That's just one of many possibilities, but considering rational range of outcomes for PM, vs that of a realatively more expensive S&P 500 (which historically returns 6-8% per year including dividends), I think PM has a very good chance of outperforming for the foreseeable future, particularly if the market doesn’t do very well overall.

And, perhaps more importantly, if I’m wrong, you’ll still do ok. (4.9% forward dividend yield provides significant downside protection as long as profits remain stable)

This, like all 20punches picks, is intended to be an asymetrical bet - heads you win big, tails you still do ok.

PM outperform.

Member Avatar 20Punches (45.46) Submitted: 4/1/2014 3:36:09 PM
Recs: 0

Apologize for the error - this is not a Q12014 pick, it is my 2nd pick of 2014

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