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PMI Manufacturing Facility. Source: Company website.
Currencies are causing a major headache for multinational companies. Domestic companies that do business outside the United States are seeing their revenue and profits artificially slashed by unfavorable currency fluctuations. When the U.S. dollar strengthens, it hurts companies that generate a high percentage of their sales overseas, because those international sales are converted into fewer dollars.
No company knows the pain of a strong dollar better than Philip Morris International. Philip Morris' 2014 results look downright ugly. But investors should know that while Philip Morris is being victimized by negative currency effects, the company's core operating results were actually very good last year. Philip Morris' stock price declined 5% over the past year, badly lagging behind the market, but investors are unfairly punishing the company. Those investors who focus on what really matters are likely to be rewarded for their patience.
Results aren't nearly as bad as they seem
On the surface, Philip Morris looks like a business that's in big trouble. Net revenue and earnings per share declined 4% and 9%, respectively. Because of this, it's no surprise that the stock is down in the past year, as investors have clearly sold off based on the ugly headline numbers. But there's a big caveat to these results.
Currency fluctuations shaved a whopping $0.80 per share, or approximately $1.2 billion, off Philip Morris' full-year earnings per share. Revenue excluding currencies and excise taxes increased 2%. Excluding the impact of currency and a one-time asset impairment charge, Philip Morris actually grew EPS by 7% year over year. Consider that close peer Altria Group saw operating profit decline by 5% last year, while Philip Morris International's operating profit was flat excluding currency. This is noteworthy, because as a U.S.-specific operator, Altria doesn't have currency as a headwind like Philip Morris does. Evaluating their core respective businesses reveals that Philip Morris is actually in a stronger fundamental position than Altria.
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Fortunately, Philip Morris is taking action against currency movements. The company expects 2015 earnings to be reduced by $1.15 per share just because of currency. Of the total currency impact, 11% is due to movements in the Japanese yen. In response, Philip Morris is hedged at 60% of its sales in Japan, which will help mitigate the impact on the bottom line this year.
Another key advantage Philip Morris International has over Altria is that it is focused on international markets, where the regulatory environment is not nearly as restrictive as the United States. This was the impetus for Altria to spin off Philip Morris in 2008. This is significant because Philip Morris is actually seeing volumes still increasing in several markets. For example, Philip Morris grew volume by 1.9% in Indonesia in 2014, and it expects another 2% volume increase this year. By comparison, Altria's Philip Morris USA segment saw cigarette volume decline by 3% last year.
Why 2015 will be another good year
Philip Morris International investors have a lot to look forward to this year, despite the impact currency is currently having on the top and bottom lines. Excluding currency, Philip Morris' outlook calls for 4%-6% revenue growth and 8%-10% earnings growth in 2015.
Investors should also be excited about the company's reduced-risk product, iQOS electronic cigarette, which heats rather than burns tobacco. The company introduced iQOS in two initial test markets, Japan and Italy, last November. According to a management presentation, while it is still too early to make a quantitative assessment, the results were generally very positive, and the early performance of iQOS either met or exceeded internal forecasts. Importantly, awareness of these products is already high. Adult awareness reached 34% in Nagoya, Japan. Because of this, Philip Morris will take iQOS national in those two countries and expand to several additional markets throughout 2015.
It's reasonable to believe Philip Morris can carve out a significant slice of the reduced-risk market, because the company maintains one of the most valuable brands in the world. Philip Morris increased market share of its flagship Marlboro cigarette brand last year by 30 basis points. It also strengthened its position of both the L&M and Chesterfield cigarette brands. This further cements the point that Philip Morris remains a strong company with powerful brands, despite the near-term currency headwind.
Philip Morris International: A gem hiding in plain sight
The bottom line for Philip Morris International investors is to not get caught up in the scary headline numbers. Results were weak last year, but that was due entirely to currency fluctuations. Meanwhile, the underlying business remains very strong. Philip Morris generates a lot of cash and rewards shareholders with a 5% dividend yield.
Philip Morris International expects to continue taking market share in its key regions this year, and it has a potential ace up its sleeve in the form of its reduced-risk portfolio. This is why management expects continued organic revenue and earnings growth in 2015.
The article Why Philip Morris International Is a Hidden Gem originally appeared on Fool.com.
Bob Ciura owns shares of Altria Group. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
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