BID & ASK: The Case Against Philip Morris
Tell us what you think in MO's Board.
Tom Byrne (11/5/99)
Investors have long referred to Philip Morris (NYSE: MO - Quotes, News, Boards) as ‘Big MO.' I think it deserves a new nickname: Little MO.
There is discussion all over the place, especially in financial Web sites (including ours) and of course chat rooms, saying that now is a great time to bottom-fish the stock.
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Au contraire my friends. I wouldn't touch Little MO with my money -- or my cat's money.
The company doesn't have the financial reserves or the cash flow to fight its battle against the State Supreme Courts over medical reimbursements for smokers who developed lung cancer. Tobacco companies have already lost two large jury awards, so the trend is against them.
Little MO has $17.2 billion in goodwill, an intangible asset that will disease the company's balance sheet as more and more reserves are needed to settle lawsuits. The company has $4.4 billion in cash. Most importantly, Little MO has $16 billion in total debt versus $15.9 billion in shareholders equity, a very scary ratio.
It has a liability for “Accrued Settlements” of $2.7 billion, a liability that will just keep growing because state after state is going to side in favor of smokers and against the tobacco companies. It's David vs. Goliath and we all know the outcome of that little donnybrook.
Anyway, smokers get cancer. It's not too hard for juries to be sympathetic with smokers (back in the 1950s Ted Williams, the great baseball player, used to advertise that Lucky Strikes were “healthy” cigarettes; that's why he smoked them).
Philip Morris' market cap equals $56 billion. Its debt load represents 29% of its market cap and more than 100% of its shareholders equity. Little MO's current ratio equals 1.2 times. Worse, its quick ratio equals 0.6 times. Tangible book value is negative.
Insiders hold less than 1% of the shares outstanding. Over the last six months, while the stock has been tanking, there has been limited insider buying. But 10 insiders have sold over 262,000 shares into the decline, albeit at prices above current levels.
But anyone who watches insider trading activity will tell you, when insiders are selling while the stock is declining, that is a very bad sign for the future performance of the stock. When insiders are selling when the stock is near a five-year low that is even worse.
To its credit, Little MO generated $7.4 billion in cash flow from operations in the first half of 1999. But that will not be enough to cover its debt payments and fund the reserves it needs to settle the lawsuit settlements it faces over the next ten years. And the company currently carries a generous 7.1% dividend yield.
Little MO has two choices. Break up into its three components, which includes Kraft Foods, Miller Brewing and, of course, the tobacco unit. Or it could throw all its money and resources at its legal defense, hold up the courts for years and drain its cash flow from all of its businesses. The second choice is a dead loser. The former choice is better, but I wouldn't invest in the company for that reason, nor do I expect Little MO to make that choice.
To make matters worse, Little MO is a prime candidate to be dropped from the Dow 30 Industrials the next time The Wall Street Journal decides to shuffle that index. That means a ton of money will pour out of that stock as indexers dump it in favor of the company that replaces it. However, considering that the index's components were just recently shuffled, a new re-jiggering does not appear imminent.
Bottom Line:
Stay away from Little MO. Invest in small caps. They're safer.
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