Think of one flaky, expensive stock that's cost you money over the past year, and then try to imagine its opposite. Your answer might be
As companies go, it's about as far as you can get from the tech flameouts that fixated on revenue growth at the expense of profits. In a word, Philip Morris is the antidot-com. Its stock bottomed last spring, around the same time tech highfliers were peaking, but went on to soar amid the rout in growth stocks, up over 180% in the past 12 months.
Is it the right place to go for investors fed up with technology? Depending on your risk tolerance, it might be worth a look.
Over the past year, the company's prospects have continued to brighten. In the wake of new legal developments, the constant antitobacco lawsuits that have dogged it are looking less threatening, and the
administration is expected to be friendlier toward tobacco than its predecessor. Philip Morris still sells at a
price-to-earnings ratio of nearly half the average of the
. And while sales growth hovers in the single digits, at least it's reliable growth.
That stands in marked contrast to the situation at many tech companies, which have whined about an inability to forecast their earnings accurately and, in some cases, sharply downgraded their outlook over a period of mere weeks.
Also, though the stock has already seen tremendous gains, it's still well within its historic trading range. Some see more room for appreciation. In December,
Marc I. Cohen forecast that the stock could rise to $75 by the end of 2001. Another analyst,
Martin Feldman at
Salomon Smith Barney
, has a price target of $65. It's in the low $50s these days.
One big reason investors in Philip Morris like it so much is because it acts like a giant cash machine. Last fiscal year, the tobacco powerhouse raked in $8.5 billion in profits. "It's one of the world's most consistently profitable cash-generating businesses," says James Gipson, president and co-manager of the
Clipper fund, which has a 6.39% weighting in the stock.
Investors appreciate that cash stream all the more because some of it gets channeled to them in the form of fat dividends. According to
, Philip Morris boasts a dividend yield of 4.2%, vs. a yield of 1.1% for the S&P. The company has also earmarked cash toward an ambitious stock buyback program it launched two years ago.
Even by the high standards of the tobacco industry, Philip Morris is exceptionally well managed, says Gipson. Competitors fear it; though industry volumes are expected to decline by about 1% annually over the next few years, the company is winning close to 1% new market share each year, according to Feldman. It already has a 51% market share in the U.S. tobacco market. He predicts accelerating earnings growth for the stock, from 11% in 2001 to 15% by 2003, with the majority of the growth coming from its core tobacco division.
Meanwhile, the company's food division, while often overlooked, is highly respected.
, home of brands like Oreos and Tang, "is one of the best -- and one of the largest -- food companies in the country," says Gipson. Plus, Philip Morris' $18.9 billion acquisition of
last year should allow for economies of scale on distribution and advertising. The company has said it plans to spin off part of the combined Kraft and Nabisco food businesses, probably some time early this year.
Ahead of the Cigarette Pack
But besides its many selling points, Philip Morris certainly has its downside. First, it sells a product that causes many of its customers to get sick and die, and for that reason, many people despise the business. Besides being one of the most profitable companies around, "It is also one of the most reviled," Gipson acknowledges. "Many people would prefer not to own it."
Beyond the fact that it doesn't show up in socially conscious funds, the looming threat of litigation related to peddling "cancer sticks" puts a huge cloud over the company's earnings prospects. The biggest worry of all is that Philip Morris will eventually be called to make amends for its business, on a scale that could theoretically bankrupt it. The company is wreathed in antitobacco lawsuits. While it's shown a remarkable ability to dodge the bullets so far, there's little doubt it will be shelling out money for lawyers for years to come.
It's already on the hook for one major settlement. In 1998, tobacco companies, including Philip Morris, cut a deal with the states to fork over more than $200 billion over 25 years to pay for smoking-related health care costs. So far tobacco makers appear to have financed those payouts with relative ease by hiking the price of cigarettes.
But though there are plenty more lawsuits that could pose a risk to tobacco companies' financial health, observers say the litigation threat has lessened in the past year. Last fall, in a major antitobacco case being pressed by the
, a judge threw out two of the government's arguments as irrelevant. While the case is continuing on narrower grounds, some observers have questioned whether the government will pursue the tobacco industry as aggressively under the Bush administration. Solly's Feldman says the last five individual lawsuits against tobacco makers have either been won by the industry or have resulted in a mistrial.
The tobacco industry is also appealing a massive $145 billion injury award to smokers in a Florida case. Ironically, the size of that award scared into existence a new pro-tobacco constituency: the state governments that have a vested interest in keeping the tobacco companies healthy because of the 1998 settlement. In the wake of the $145 billion award, the Florida legislature passed a bill capping the size of the bond that tobacco companies would have to post if they lost the case. "One of the consequences of the states' being addicted to tobacco money is that they are protecting the goose that lays the golden egg," says Clipper's Gipson.
In short, after some scares in '99, the legal outlook for the industry has considerably improved -- not that its record in the courts has really been that bad. "No member of the U.S. tobacco industry has ever paid any plaintiff as a result of a court award or loss," Feldman points out. "All the cases that have come to appeal so far have been won."
Of course, investors should still be mindful of the potential for litigation problems. As Gipson puts it, "Anyone who buys the stock should have a reasonably strong stomach for occasional news headlines."
On the fundamental side, another problem the company faces is growth, or a lack of it. The domestic tobacco division, which contributes about a third of profits, is likely to see flat growth over the next few years, though overseas markets could help to compensate, with volume expected to increase around 5% annually. According to Morningstar, foreign sales account for 51% of the company's revenue. The downside of that reliance on overseas markets, by the way, is that a strong dollar could take a bite out of earnings.
Overall, revenue for the fiscal year ended last December increased a mere 2%. The upshot: While it's tremendously profitable -- net income for the same period rose 11% -- Philip Morris just isn't growing much.
And what about valuation? After the stock's meteoric rise over the past 12 months, there's certainly less upside than there used to be. "For anybody who buys in at $50 instead of $20, there's not as much upside," points out Donald Yacktman, whose
Yacktman fund has more than 11% of its assets in Philip Morris. The stock, which was trading at $50.04 Wednesday, briefly dipped below $20 last spring.
Still, at a P/E of 13.5, it's trading at only slightly above its median P/E of 13.1. Over the past decade, according to
, it's traded in a range between 6.1 (in February 2000) and 18.4 (way back in December 1991).
Feldman, the Salomon analyst, advances an investment thesis that would support further increases in price. Philip Morris currently represents a weight of 0.9% in the S&P 500, he points out. If it passes the 1% or even 2% mark -- which seems possible, given the scarcity of recession-resistant stocks -- that might prompt institutional investors to shift from a zero weighting to at least a neutral position, which would push the stock higher.
Philip Morris may not be what you'd call a growth stock, and as the target of reams of lawsuits (and generalized hostility) it still looks risky by the standards of many value investors. But neither is it the kind of company that's likely to get body-slammed by a recession. Nervous consumers may stop buying cars and stereos, but they're not likely to stop smoking cigarettes. If anything, they may smoke more.