Philip Morris Stock Just Hiked Its Dividend, But It’s Not Enough (NYSE:PM)

bmcent1 On September 12, Philip Morris (NYSE:PM), the world’s largest tobacco company by market cap, hiked its dividend by 3.8% to $1.35/share per quarter or $5.40/share when annualized. With this dividend hike, and the fact that PM stock is ~41% higher than its April 2024 low (not including dividends), it’s a good time to take a look at PM’s valuation. After analyzing it, though, I’ve come to the conclusion that there may not be a lot of upside potential left. Therefore, I rate PM as a Hold, and I think Altria (MO) could be a better-priced stock. I actually shared a similar opinion in my past article about PM stock from February 27, 2023, including my opinion that Altria was the better pick based on its valuation and higher profitability, and I believed that PM stock was potentially overpriced. While Altria has performed well since then, PM stock has outperformed it (likely due to its higher revenue growth), so it’s safe to say that I was wrong about that. Nonetheless, I’m giving myself a second chance. Still, since PM is a consistent free cash flow generator with growth ahead, I will consider adjusting my rating to a Buy in the future if the share price falls enough. PM’s Dividend Just Got Hiked And Can Keep Growing Despite High Debt As stated above, PM hiked its annualized dividend to $5.40/share. This now gives it a forward yield of 4.33% based on a share price of $124.61. Despite the company’s $49.15 billion in debt, with only $4.81 billion in cash, the dividend looks safe and has room to grow. That’s because the company has generated $6.51/share in free cash flow in the past 12 months and an average of $6.08/share per year from December 2019 to 2023 (per Finbox). For 2024, analysts (per simplywall.st) expect free cash flow of $9.746 billion, which would translate to free cash flow per share of about $6.27 based on a share count of 1.555 billion. For 2025, analysts expect $10.9 billion in free cash flow ($7.01 per share). Per the company’s latest investor presentation, it expects $36-39 billion in cash from operations from 2024 to 2026 and $3.5-3.7 billion in capital expenditures during the same time frame, with 75% of CapEx going toward smoke-free products. At the midpoint, that comes out to an average of $11.3 billion ($7.27/share) in free cash flow per year, so the dividend looks safe, with room for more increases along the way. On top of that, the company plans to reduce its debt level. It wants to reduce its net-debt-to-adjusted-EBITDA ratio from 3.0x in H1 2024 to 2.0x by the end of 2026. After it accomplishes that, it will have more flexibility to increase dividend payments. Factors That Are Driving Growth As many of you probably know, Philip Morris is seeing impressive momentum in the smoke-free market. In fact, smoke-free products made up just 0.7% of revenues in 2015 but have jumped to 38.3% of revenues as of H1 2024. By 2030, PM has a goal of generating over two-thirds of its net revenues from smoke-free products. Philip Morris Smoke-Free Ambitions (Philip Morris’s Investor Presentation) In this segment, Philip Morris sells a few products. These include IQOS (a type of heated tobacco product), VEEV (a vape), and ZYN (a nicotine pouch). The growth of its smoke-free segment is summarized in the quote below. In the Q2-2024 earnings call, PM’s CFO, Emmanuel Babeau, said the following: Q2 HTU adjusted IMS volume grew by plus 10.2%, in line with our expectation. This includes the impact of the characterizing flavor ban in Europe, most notably in Italy this quarter. Total smoke-free adjusted in market sales volume grew plus 11.2% in Q2 and plus 13.1% in H1. This includes our oral smoke-free portfolio powered by ZYN with Q2 pouch unit volumes up by plus 20%. U.S. ZYN shipment grew by plus 50% to 135.1 million cans. This does not include the promising result of our e-vapor business where volume grew strongly to the equivalent of 0.7 billion units on a year-to-date basis. Meanwhile, even cigarette volume growth was positive, at 0.4% for the quarter. Plus, the global cigarette market is forecast to see 2.46% annual sales growth from 2024 to 2029 (per Statista), which is not bad, considering that volume itself is expected to decline. Nonetheless, with such higher growth in the smoke-free segment, it’s easy to see why PM expects two-thirds of its revenue profile to be smoke free by 2030. Looking At The Valuation Let’s incorporate the recent dividend hike into the stock’s valuation. I will show multiple two-stage DDM valuations so that you can have a better idea. Valuation #1: I’ll be using a 6.58% discount rate for the first valuation based on the cost of equity I calculated with the CAPM Model. To help me calculate the cost of equity, I used the following inputs: 5% equity risk premium (taken from Kroll) 3.68% risk-free rate (I used the 10-year US Treasury yield) Five-year monthly beta of 0.58 Next, I input the company’s forward dividend per share of $5.40. In the “current earnings” section of the calculator, I put its TTM free cash flow per share of $6.51, as I believe FCF is generally a better indicator for dividend safety/trajectory compared to net income. For the high-growth stage, I put 3.8%, in line with the company’s recent dividend increase, and I set 20 years for the duration. This means that I’m assuming 3.8% dividend growth per year for the next 20 years. I chose 20 years because it’s reasonable to think that the high growth in the smoke-free market will last for a while, as nicotine products are addictive and should continue to gain traction. Next, I set the terminal dividend growth rate to a conservative 2%, as it’s roughly in line with the annual growth of the economy over the long term. Lastly, I set 75% as the stable stage payout ratio because PM’s investor presentation says that the company has a “target dividend pay-out ratio of 75% over time.” Below, you can see the inputs. Philip Morris Stock DDM Valuation (Author) And with these inputs, I get a fair value of $146.87/share, which is 17.9% above the current share price. Philip Morris Stock DDM Valuation (Author) Valuation #2: If you think that discount rate is too low, then no worries. If you use the company’s re-levered beta of 0.874 (per simplywall.st), which factors in the company’s debt level, you get a discount rate of 8.05%. In that case, keeping all the other inputs the same above, I got a fair value of $109.67/share. This is 12% lower than the current price. Valuation #3: Perhaps you think I’m factoring in very little growth. So, let’s increase the “high-growth annual dividend growth rate” to 5% and keep the 8.05% discount rate. I’ve also increased the stable stage payout ratio to 80% with the idea that down the line, PM will be even more mature of a company and may raise its target payout ratio. Philip Morris Stock DDM Valuation (Author) Using the inputs above, the fair value jumps to $130.57/share, 4.8% higher than the current price. Philip Morris Stock DDM Valuation (Author) When analyzing these valuations, it’s important to remember that PM has 3-, 5-, and 10-year CAGRs of 2.7%, 2.66%, and 3.3%, so it’s not known as a fast dividend grower. Still, its dividend was hiked by 3.8%, indicating accelerating growth, and this can accelerate further after the company reduces its debt. Overall, though, the highest upside I got from the three valuations was 17.9%. That’s just not enough to excite me to buy the stock, especially after its recent rise. The Bottom Line on PM Stock Philip Morris is a high-quality company that generates lots of free cash flow and has a good amount of growth ahead in its smoke-free category. As the firm becomes less dependent on cigarette sales in the future, the risks associated with investing in a stock that’s in a declining-volume market will become smaller. Additionally, the company just hiked its dividend, and it has more room to grow. The yield is also solid, at over 4.3%. However, when analyzing its valuation and looking at its historical dividend growth rate more closely, there may not be too much upside ahead. This is especially true because the stock has gained so much in a short amount of time, so a pullback can happen at any moment. In the final analysis, Philip Morris is a solid company at what seems to be a fair price, but it’s just not enough to get me excited. Therefore, I rate it as a Hold for now.

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