Philip Morris says cigarette sales in many places could end in a decade and they’ve got a ‘safer’ product to replace them


Philip Morris International Inc. thinks the sale of cigarettes could come to an end in countries around the world in the coming years, but have no fear, because they’ve got another product ready to sell that offers a “safer” nicotine fix.

Philip Morris
PM,
+4.02%

and the Food and Drug Administration announced this week that the company’s IQOS “electrically heated tobacco system” has been given the green light to market as a safer alternative to cigarettes.

Now designated as a “modified risk” product, the company can promote these items “as containing a reduced level of or presenting a reduced exposure to a substance,” according to the FDA statement.

Philip Morris, the company behind Marlboro cigarettes, describes these alternative products as heating rather than burning tobacco, which a cigarette does. Burning tobacco, which reaches 600 degrees Celsius, “contains high levels of harmful chemicals,” according to the company’s website. The tobacco heating system (THS) heats tobacco to 350 degrees Celsius.

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“However, THS is not risk-free and delivers nicotine which is addictive,” the site says. Philip Morris has turned its focus to the IQOS product, with Philip Morris’ Chief Operating Officer Jacek Olczak saying at the Deutsche Bank dbAccess Global Consumer Conference last month that the company is committed to “working towards realizing [the] potential of this opportunity,” according to a FactSet transcript.

The development comes at a time when Philip Morris is preparing for the end of cigarette sales.

“I am convinced that it is possible to completely end cigarette sales in many countries within 10 to 15 years, but for that to happen, manufacturers and governments need to work in the same direction,” said André Calantzopoulos, chief executive of Philip Morris, in a letter to stakeholders published with the company’s report on its environmental, social and governance (ESG) efforts.

Calantzopoulos notes the “skeptical stakeholders” like international organizations and the media that “doubt that harm reduction through smoke-free alternatives is sound public health policy or argue that our purpose-driven strategy is nothing more than window dressing.”

He highlights other areas where advice to reduce a hazardous activity is accepted, such as lowering sugar intake for better health.

“I feel strongly that people who smoke cigarettes, the most harmful nicotine-containing product, should not be denied the opportunity to switch to better alternatives,” Calantzopoulos wrote.

In 2019, Philip Morris sold 706.7 billion cigarettes, down 4.5% from 2018, according to a June CFRA report. Over the next few years, CFRA forecasts that cigarette consumption will fall 3% each year.

Shipments of heated tobacco products, on the other hand, soared 44.2% to 59.7 billion units in 2019.

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There had been discussions about merging Philip Morris and Altria Group Inc.
MO,
+4.32%

, however those talks ended without a deal. This is a good thing for Philip Morris “given heightened regulatory and legal headwinds surrounding e-cigarettes in the U.S., as Philip Morris’ IQOS product underwent a lengthy FDA review process before getting the green light for sale in the U.S. in April 2019,” CFRA said.

CFRA rates Philip Morris stock buy with a 12-month price target of $95.

“Despite declining cigarette consumption in developed markets, we look for pricing gains and growth in emerging markets to support revenues,” CFRA said. “We think the launch of Philip Morris’ heated tobacco product, IQOS, will lead to market share gains and help offset cigarette volume weakness.”

The company reported earnings and revenue that beat expectations in the most recent quarter. The stock is down 15.1% for the year to date while the Dow Jones Industrial Average
DJIA,
+1.43%

has fallen 9.3% for the period.

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While the cigarette business was hurt by restrictions imposed by coronavirus-related lockdowns and plummeting duty-free demand at global travel hubs, Olczak said on the April earnings call that device and heated tobacco sales were showing the potential to regain pre-COVID momentum.

Philip Morris’ goal now is to move into a “smoke-free future,” said Huub Savelkouls, the company’s chief sustainability officer, in a post on LinkedIn. Philip Morris has cut its cigarette portfolio by more than 700 SKUs (stock-keeping units) over the last four years and aims to move 40 million smokers of its cigarettes over to smoke-free products.

Savelkouls says engagement, including between the company and the investment community, is needed to achieve change.

“Making cigarettes obsolete can be achieved much more rapidly through inclusivity and openness,” Savelkouls wrote. “Our goals are really not that different and that is where the potential for creating impactful change lies: working together towards making the world smoke-free.”



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These stocks may be your best choice for income as interest rates keep falling


Income-seeking investors have faced the same problem for four decades — declining bond yields. But it keeps getting worse.

Richard Saperstein, chief investment officer of Treasury Partners in New York, tailors strategies across asset classes for clients. He narrowed two approaches for investors who need to find a way to squeeze more income from their portfolios.

On Tuesday, the Federal Open Market Committee lowered the federal funds rate by 50 basis points to a target range off 1% to 1.25%. Yields on short-term U.S. Treasury bills declined, as expected, but the yield on 10-year Treasury notes
BX:TMUBMUSD10Y
declined by 8 basis points to 1.02%. That was down from 1.92% on Dec. 31. Then on Wednesday, the 10-year yield dipped below 1.00%.

“A 1% 10-year yield reflects recession concerns and global negative debt,” Saperstein said during an interview March 4. He sees a long-term risk of a bursting of the bond-market “bubble,” pointing to about $14 trillion in bonds with negative yields issued outside the U.S., with some denominated in dollars. “At some point this dollar-denominated debt is going to have to be paid off. The risk is the dollar continues to strengthen. It could come home to roost at some point.”

Saperstein, 60, founded Treasury Partners in May 2009 as a division of High Towers Advisors, after his team left J.P. Morgan Chase, which had acquired the advisory group as part of its acquisition of the distressed Bear Stearns in May 2008. Treasury Partners manages $8 billion in client assets.

What income-seekers can do now

Investors who need income “now have a fundamental decision to make,” Saperstein said. “Do they take more risk for returns or keep this risk profile and accept massively lower returns?”

For investors who cannot take additional risk, the answer is simple: Your income will fall.

For investors who can only assume moderately higher risk, Saperstein pointed to corporate bonds with short maturities, which have had improving spreads over the yields of U.S. Treasury securities with the same maturities. He named three examples:

• Notes issued by Kraft Heinz
US:KHC
that now have a yield to maturity of about 2.40% and mature in July 2022.

• Canadian Natural Resources
US:CNQ
notes that yield about 2.10% and mature in February 2025.

Newell Brands
US:NWL
notes that yield about 2.69% and mature in April 2023.

Those yields are low, but they are attractive when compared to a yield below 1% for 10-year Treasury notes or 0.71% for five-year Treasury notes
BX:TMUBMUSD05Y.

Dividend stocks

“If [investors] are looking to generate equivalent levels of yield that they have been used to over the past 10 years, they cannot do it in the fixed-income market,” Saperstein said “If return is critical and the investor is willing to assume more risk, our discussions center around shifting your allocation away from fixed income and toward equity.”

Richard Saperstein, chief investment officer at Treasury Partners in New York.


Treasury Partners

That means stocks with attractive dividend yields well-supported by cash flow. Saperstein said he also prefers companies that are deploying some of their free cash flow by repurchasing shares. A lower share count means shareholders’ percentage ownership increases, and that per-share results are boosted.

Saperstein cautioned that this approach “changes your risk profile.”

“Your fixed-income investor now owning equities takes on a much greater volatility perspective in their portfolios,” he added. So if you have had difficulty tolerating the volatility since the S&P 500
US:SPX
hit its last closing record Feb. 19, you may have to rethink your approach.

Saperstein named as examples three stocks of companies that are buying back shares and also have attractive dividend yields:

• Shares of CVS Health
US:CVS
have a dividend yield of 3.20%. One way to gauge a company’s ability to support its dividend is to look at its free cash flow yield. This can be done by dividing the past 12 reported months’ free cash flow per share by the current share price. On this basis, CVS’s free cash flow yield is 12.68%, leaving massive “headroom” for dividend increases, share repurchases, business investment or other corporate purposes.

• AT&T’s
US:T
dividend yield is 5.73%. The free cash flow yield is 10.90%, leaving headroom of 5.17%.

• Gilead Sciences
US:GILD
has a dividend yield of 3.67% and a free cash flow of 8.81%, with headroom of 5.14%.

One thing to consider is these are trailing free-cash-flow yield calculations. Disruptions in supply chains and demand for products and services as the coronavirus unfolds may lower cash flow considerably over the next two quarters.

Saperstein said his “base case” is that “by April, the virus will be under control.” He expects slower, or even negative, economic growth in the U.S. for the first half of 2020, but also said: “We have tremendous factors that can lead to a second-half recovery,” including monetary policy and pent-up demand.

Screening more dividend stocks

The three companies that Saperstein named are quite large, with an $81.5 billion market capitalization for the smallest, CVS. So here is a screen of the 15 S&P 500 companies with market-caps of at least $50 billion that have had the highest free cash flow yields over the past 12 months while also having current dividend yields of at least 3.00% and stock-repurchase plans in place. The list is sorted by dividend yield:

Company

Ticker

Dividend yield

Free cash flow yield – past four quarters

‘Headroom’

Altria Group Inc.

US:MO 8.02%

9.75%

1.73%

AT&T Inc.

US:T 5.73%

10.90%

5.17%

AbbVie Inc.

US:ABBV 5.39%

9.82%

4.43%

Wells Fargo & Co.

US:WFC 5.03%

17.38%

12.35%

International Business Machines Corp.

US:IBM 5.03%

10.84%

5.81%

Broadcom Inc.

US:AVGO 4.74%

8.12%

3.38%

Verizon Communications Inc.

US:VZ 4.42%

7.72%

3.30%

PNC Financial Services Group Inc.

US:PNC 3.67%

12.38%

8.71%

Gilead Sciences Inc.

US:GILD 3.67%

8.81%

5.14%

U.S. Bancorp

US:USB 3.64%

11.34%

7.70%

Cisco Systems Inc.

US:CSCO 3.60%

8.69%

5.10%

ConocoPhillips

US:COP 3.49%

8.44%

4.95%

CVS Health Corp.

US:CVS 3.20%

12.68%

9.49%

Morgan Stanley

US:MS 3.15%

44.31%

41.15%

Source: FactSet

If you see any securities of interest here, it is important to do your own research and not only look at yields and cash flow, but also to consider a company’s business strategy and its ability to remain competitive for the next decade, at least, before considering an investment.

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