From this week's Barron's:
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A Second-Hand Look At Big Mo's Prospects
Philip Morris has rallied lately despite weakness in consumer stocks. The stock known as Big Mo because of its ticker symbol rose 2 3/8 last week, to 43 13/16, and is up four points in the past two weeks.
"People had been ignoring a lot of favorable news until recently," says Gary Black, tobacco analyst at Sanford Bernstein. "Philip Morris could hit 50 by Labor Day and 60 by year's end."
Philip Morris traded as low as 35 in mid-May on concerns that the severe McCain tobacco bill could pass Congress. But with the McCain legislation dead and several court rulings going in favor of the tobacco companies, the outlook for Philip Morris has brightened. It should be said that even with the latest rally, the stock is still down on the year, and below its peak of 48 after the accord between the industry and state attorneys general in June 1997.
The Dow dropped 54 points to 8883, hurt by a 143-point loss Friday. It held up better than other major indexes, falling 0.6%, while the S&P 500 was off 1.8%. Helping the Dow were gains in Philip Morris and IBM; Procter & Gamble was the big loser.
Philip Morris is sitting on a growing mountain of cash because it suspended its aggressive share repurchase program last June and has refrained from raising its dividend since then. These actions were taken because the company didn't want to flaunt its financial strength while negotiating for the lowest possible payment in a tobacco settlement.
By Black's calculation, the company now has over $4.5 billion in cash, and he sees Philip Morris starting an aggressive repurchase program in October, after Congress adjourns. Philip Morris, he says, could buy back $1 billion of stock in the fourth quarter and increase its dividend, now running at a rate of $1.60 annually, to $1.75. That would lift the stock's yield to 4%, tops in the Dow.
Black notes that Philip Morris trades at a very reasonable 14 times projected 1998 profits and at 12.5 times estimated 1999 profits of $3.50. Philip Morris's multiple relative to the S&P is near a historical low. The company's valuation looks even more tempting, Black argues, because of concerns about profit growth in the rest of the consumer sector. Philip Morris also has a valuable asset in its Kraft food business, which could be worth $25 per share. A Kraft spinoff could come in the next year or two.
"The improving external environment is starting to be reflected in the tobacco stocks," says Ross Margolies, manager of the Salomon Brothers Capital fund, which has a big position in Philip Morris and RJR Nabisco.
Another factor that may be helping Philip Morris is that Fidelity Investments may have stopped selling the stock. Fidelity was the dominant holder of Philip Morris at year-end, with a monstrous position of 200 million shares. Fidelity sold 20 million shares in the first quarter and is rumored to have sold a similar number in the second as the fund company's portfolio managers faced greater internal pressure to align their portfolios more closely to the S&P 500. This has resulted in selling of stocks like Philip Morris, in which Fidelity has been overweighted, and buying of companies like Gillette that were underrepresented in its portfolios.
Black also caused a bit of a stir last week when he wrote that Philip Morris had looked at buying UST, the dominant maker of smokeless tobacco, a few years ago and "likely remains interested." UST rose 3/8, to 27, but is still down 28% this year on concerns about pricing and market-share losses. UST trades at just 12 times projected 1998 profits and yields 6%. Black sees UST hitting 40 in 12 months and says it could be worth as much as 50 in a takeover.
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