Investment Thesis by Merrill Lynch:
8/18/03
Late on Friday, Judge Byron in Madison County, Illinois ordered Philip Morris USA (“PMUSA”) to post a bond of $12.1billion in the class action claim known as Price/Miles. Judge Byron also stayed all proceedings related to the bond for 60 days, in order that the defendant PMUSA can appeal this order to the Illinois Supreme Court. This ruling by Judge Byron of the trial court appears to comply entirely with the recent decision, of the Illinois Fifth District Court of Appeals. In other words, it should not have come as too much of a surprise to investors.
We have in many previous notes described our view that the market has broadly adopted an unduly conservative view of MO’s US tobacco litigation challenge. The company’s current P/E multiple of 8.7 times our 2003 EPS estimate of $4.58 adopts an unduly conservative approach both to the litigation and fundamental issues facing the company. In our opinion, the tobacco stub, being valued at about $17.91 or about 3.5x EV/EBITDA is at the lower end of its trading range and may well continue to appreciate over the coming months. By contrast, RJR and BAT are trading at higher valuations of 7.1x and 6.1x, respectively. We would also note that we consider MO’s annualized dividend of $2.56 to be secure. In August, we forecast a DPS hike of 4.7% to $2.68. Both of these statements, are however dependent on the bonding issue in Price/Miles being satisfactorily resolved for PMUSA. Our price target of $50 implies total potential returns of 32%, considering the current dividend yield of 6.6%. Our target envisages the tobacco stub appreciating by some $10 to about $28.06 from the current $17.91. In essence, we think that the market’s concern with the two key litigation issues facing PMUSA, namely Price/Miles and the DOJ suit, will likely wane over time. The recent State Farm decision has broadly resulted in investors perceiving individual suits as less threatening than previously. In essence, while the bonding issue in Price/Miles has the potential to cause some serious hardship for PMUSA in the near term, we continue to believe that the overall litigation challenge is likely to continue to soften. |
