Philip Morris (PM) has experienced one of its strongest rallies ever in months, with shares surging over 32% in the past year. The stock is now nearing its all-time high of $123.55, a level last seen in 2017. This bullish momentum is primarily driven by impressive revenue and earnings growth, as demonstrated in the company’s latest Q2 results. However, the stock’s extended rally may constrain future return potential for investors. Given this, I am turning neutral on Philip Morris stock.
Second-Quarter Results Sustain Excellent Growth Momentum
Philip Morris’ Q2 results sustained excellent growth momentum, with total revenues rising by 5.6% year-over-year or by 9.6% on an organic basis (i.e., in constant currency and excluding acquisitions). Both the Smoke-Free business and Combustibles delivered solid growth.
Let’s take a deeper look at each of Philip Morris’ divisions and how they performed.
Combustibles Post Growth, Gloomy Sentiment Gets Flipped
As you’re aware, the market has long held a pessimistic view of the future of combustible tobacco products, largely driven by a global decline in smoking rates. This sentiment has been reflected in the steady decline of cigarette shipment volumes, a trend observed across all major tobacco companies in recent years.
Philip Morris has not been immune to this, with its tobacco shipment volumes experiencing mid-single-digit declines. The company has partially offset this impact through regular price increases, but the Combustibles division has long been viewed as one destined for continual decline.
However, this narrative appears to be shifting. Recently, shipment volumes have begun to stabilize, and along with Philip Morris’ strategic price hikes, this segment has started to contribute positively to growth. Notably, second-quarter cigarette volumes saw a slight increase of 0.4% year-over-year. When mixed with high single-digit price increases, this resulted in 4.8% organic growth compared to last year.
Although foreign exchange headwinds tempered this growth, the Combustibles division still achieved a 1.2% year-over-year revenue increase. This shows that Combustibles is not just a declining cash cow for the company but a division that continues to generate revenue and earnings growth. I believe that this has likely flipped the long-term sentiment surrounding the division in a more positive direction in a more positive way and has contributed to the stock’s recent rally.
The Smoke-Free Business Sustains Double-Digit Growth
In addition to the strong performance of the Combustibles division, Philip Morris’ Smoke-Free business has sustained double-digit growth, further boosting the company’s consolidated performance. If you are not familiar with it, Philip Morris’s Smoke-Free business comprises its Heated Tobacco Units (HTU) and Oral Tobacco division. Both segments grew in the double digits, resulting in Smoke-Free revenues increasing by 13.6% compared to last year or by 18.3% in constant currency, as shown in the image shared earlier.
More specifically, HTU shipment volumes grew by a robust 13.1% compared to last year, reaching 35.5 billion units. Growth was driven by continued strong performance in Japan, robust underlying growth in Europe, and promising growth in newer markets, such as Indonesia.
In addition to solid growth in Heated Tobacco, Philip Morris bolstered its Smoke-Free category sales with remarkable gains in its Oral business. This success was driven by the momentum of ZYN, the oral nicotine pouches that became part of Philip Morris’ portfolio after last year’s acquisition of Swedish Match.
More specifically, nicotine pouches experienced substantial growth, with volumes rising from 99.5 million to 149.9 million, up 50.6% year-over-year. Again, this growth was primarily driven by ZYN, which performed on par with the overall U.S. nicotine pouch market in terms of consumer demand despite meeting supply constraints.
Internationally, Philip Morris also saw a significant expansion in its nicotine pouch volume, growing by over 50%, with particularly promising outcomes in several new markets, notably Pakistan.
Recent Share Price Gains Could Hamper Future Returns
Philip Morris’s strong performance across its Combustibles and Smoke-Free businesses has recently fueled strong share price gains. While this has been an excellent development for Philip Morris shareholders, I worry that following such an extended rally, Philip Morris stock could have somewhat limited returns, moving forward.
The recent rise in Philip Morris’ share price has elevated its forward P/E ratio to 18.4x, based on this year’s expected earnings per share (EPS) of $6.40. I believe this high valuation could limit the stock’s future gains to its earnings growth and dividend yield, as a further valuation multiple expansion seems unlikely.
It’s important to remember that many investors still view Philip Morris as a “tobacco” stock despite the company’s strong recent results. This perception has historically contributed to selling pressure, which has often prevented Philip Morris’ shares from breaking out to new highs. This likely explains why the stock has largely traded within a range in the past, driven primarily by its yield.
With the stock’s yield now hovering at just 4.4% after the recent rally—the lowest among tobacco stocks—this could once again prompt selling pressure and limit its potential for significant gains.
Is PM Stock a Buy, According to Analysts?
Looking at Wall Street’s view on the stock, Philip Morris boasts a Strong Buy consensus rating based on seven Buys and one Sell recommendation assigned in the past three months. At $115.25, however, the average PM stock price target suggests 2.35% downside potential.
If you’re looking for the most accurate analyst to follow for buying and selling PM stock, Pamela Kaufman of Morgan Stanley (MS) is your top choice. Over the past year, her ratings have delivered an impressive average return of 12.65% and boast a remarkable 95% success rate.
The Takeaway
Philip Morris has experienced a strong rally over the past year, with its most recent Q2 results sustaining the stock’s bullish sentiment. The company surprised investors with growth in Combustibles, while its Smoke-Free division continues to grow in double digits.
However, the extended rally may limit future returns, as its elevated valuation could constrain further gains. Given the somewhat elevated P/E ratio and potential resistance at new highs, I believe that a more cautious outlook is warranted.
