Philip Morris Undervalued After Uneventful Quarter

 Philip Morris International (PM) reported fourth-quarter volume, revenue, and EBIT that were exactly in line with our forecasts, although some below-the-line items led to modest upside to our estimate. The company has guided to EPS of at least $5.37 next year, which is slightly above our forecast for 2019, although this has an immaterial impact on our valuation. We are reiterating our $102 fair value estimate and our wide economic moat rating, and we believe that there is significant upside to PMI from current levels.

Total tobacco volumes declined 4.6% in the fourth quarter, dragging the full year decline down to 2.1%, with the combustible portfolio down around 3%. This is slightly steeper than our medium-term forecasts, but it includes the fourth-quarter cycling of very strong heated tobacco stick shipments last year. Pricing remains fairly strong though, with full year price/mix of 5.5%, in spite of the introduction of lower-priced heated tobacco sticks in Japan.

The consolidated operating margin of 38.4% in the full year 2018 fell by almost 2 percentage points, lending support to our thesis that the tobacco manufacturers will face significant headwinds to margins going forward. We expect PMI to deliver on its target of $1 billion in savings from zero-based budgeting program, but it seems likely that the mix shift to heated tobacco could be unfavorable, given higher customer acquisition costs and low-margin devices. This appears more than priced in to the stock at current levels, however.