Debt is no laughing matter.
The Financial Times reminded investors of this very fact recently in a short (albeit excellent piece) about Philip Morris (PM) piling on the debt to buy back shares.
Tobacco stocks of all stripes have been busy repurchasing shares in recent years to goose earnings, thereby creating the illusion of growth, but PM is really taking the cake.
Some tobacco stocks are clearly better than others; while indebtedness stands out, it’s merely one reason I prefer Altria (MO) to Philip Morris.
Read on and I’ll provide you with several others keeping in mind that a couple of wildcards — e-cigs and marijuana — could drastically change the growth trajectory for all of the major tobacco stocks — Altria included.
Tobacco stocks are no stranger to debt. But Altria at least knows how to use its debt responsibly.
Altria vs. Philip Morris – Debt Load
The Financial Times’ main argument when it comes to Philip Morris is that the company spent $56 billion on share repurchases and dividends over the past five years — $14 billion more than it generated in free cash flow.
In simple terms, PM was living beyond its means.
If you or I did that in our own lives, the personal finance self-help brigade (Dave Ramsay, Suze Orman, etc.) would label our actions frivolous and/or financially irresponsible. But because PM generated $8.9 billion in free cash flow in 2013, all is forgiven. After all, Philip Morris only paid $973 million in interest this past year, 90% of which is fixed-rate debt, or less than one-eighth its free cash.
PM’s credit facilities require that EBITDA remain at least 3.5 times its annual interest expense. At the end of 2013, Philip Morris had a ratio of 14.6, more than four times the minimum requirement, so PM could conceivably borrow four times its current debt load of $27.7 billion.
Just because it can doesn’t mean it should, however.
While approximately 65% of PM’s debt is due in 2019 or later, the reality is much of that debt will be refinanced at rates higher than the average 3.5% rate of interest it enjoys today, putting a governor on free cash flow growth.
Now let’s look at Altria’s situation.
Between 2009 and 2013, Altria paid $15.9 billion in dividends while also repurchasing $3 billion of MO stock. During those five years, Altria generated $17.2 billion in free cash flow, resulting in a deficit of $1.7 billion. However, it averaged $2.7 billion in cash on its balance sheet over those five years, leaving plenty to eliminate the deficit.
MO’s long-term debt during this period increased by about 25% from $12 billion in 2009 to $14.5 billion in 2013. In the same five-year period, Philip Morris increased its long-term debt by 139% — $11.68 billion at the end of 2008 — most of which went to share repurchases. Of all the big tobacco stocks, only Lorillard (LO) has grown its debt faster since 2009.
Philip Morris might be paying about 2 percentage points less in interest on its debt compared to Altria, but as the Financial Times quite rightly points out, someone has a debt addiction — and it isn’t Altria.
Altria vs. Philip Morris – Share Repurchases
Altria has a relatively modest history of buying back stock. In 2013, it repurchased $634 million in MO stock, another $1.1 billion in 2012 and $1.3 billion in 2011. It made no repurchases in either 2009 or 2010. The average price paid for its 101 million shares was $30.16, 38% below its July 1 closing price of $41.83.
So how did Philip Morris do? I would hope even better considering the debt it has heaped on shareholders.
Between 2009 and 2013, PM repurchased 449.4 million of its shares at an average cost of $63.20, or 33% below its July 1 closing price of $84.35. This means Philip Morris got a worse return on its investment — 33% vs. 38% for MO — despite growing its debt load six times as fast.
If I was a shareholder of PM stock, I wouldn’t be too happy with the increased leverage, especially considering the share repurchases have done little for its stock price.
Philip Morris has reduced its share count by 450 million (22% decrease) over the past five years. In 2013, it paid out $5.8 billion ($3.58 per share) to shareholders. Since the end of 2008, PM has grown its annual dividend by 132% while earnings have grown just 58%. It’s one more example of how Philip Morris has taken to living beyond its means to satisfy jittery shareholders.
To be fair, Philip Morris did pay out $4 billion in special dividends in 2007 and 2008 to Altria shareholders as part of its spinoff from its former parent, which lowered the amount available for regular dividends. That said, Philip Morris has essentially borrowed funds to repurchase shares, which lowered the share count and in turn reduced the total dollars paid out — approximately $1.6 billion — to shareholders in 2013. That doesn’t seem very shareholder-friendly to me.
Meanwhile, Altria increased its earnings 47% between 2009 and 2013 while dividends grew just 39% in the same four-year period. I’ve used 2009 as the benchmark because the special dividends it received and then paid out to shareholders in 2007 and 2008 slightly skew the numbers.
Needless to say it’s taken a more conservative approach when it comes to dividends.
Two Tobacco Stocks – One Choice
Don’t get me wrong. I think tobacco stocks make great investments, especially if you’re looking for consistent income. I also think Philip Morris has a wonderful global brand (health issues aside).
However, it seems to me that Altria is acting in a far more judicious manner when it comes to the allocation of its capital.
Philip Morris has added debt for the wrong reasons. If it had been to acquire another business, I’d be a lot more understanding. As it stands now, with dividend yields being relatively equal, I’m more inclined to own Altria.
As of this writing, Will Ashworth did not hold a position in any of the aforementioned securities.
Debt is no laughing matter.
The Financial Times reminded investors of this very fact recently in a short (albeit excellent piece) about Philip Morris (PM) piling on the debt to buy back shares. Tobacco stocks of all stripes have been busy repurchasing shares in recent years to goose earnings, thereby creating the illusion of growth, but PM is really taking the cake. Some tobacco stocks are clearly better than others; while indebtedness stands out, it’s merely one reason I prefer Altria (MO) to Philip Morris. Read on and I’ll provide you with several others keeping in mind that a couple of wildcards — e-cigs and marijuana — could drastically change the growth trajectory for all of the major tobacco stocks — Altria included.
Energy penny stocks 2019