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Philip Morris: debt addiction

The year 2014 is proving to be "truly atypical" for Philip Morris International, its boss says. This means, in short, that the company's performance will be neither as strong as it has been in the past, nor as strong as he expects it to be in the future. The company's recently released target is for earnings per share (excluding the hits from currency and plant closures) to grow by 6 to 8 per cent this year.

Over the past five years, Philip Morris' EPS grew more than 10 per cent annually, on average, despite flat sales volumes. Price increases give the top line a bump of about 5 per cent each year. Operating leverage and cost control provide another point or two of growth. And then stock buybacks kick EPS into the double digits. Meanwhile, over half of earnings are paid out as dividends, giving investors a fat yield. Nice model, smooth results and a stock that has outperformed over time.

The growth and the dividend, backed by the stability of selling an addictive product, has the shares - even after a dip last week - trading at 16 times forward earnings, above its historical average. Is this peaky, given that the company is having a wobbly year? Hard to say, when the whole market is trading at highs.

There is a worry, though. The model has depended on borrowing. Since the end of 2008, the company has spent $56bn on its own shares and dividends, and generated $43bn of free cash flow. The gap shows up as a $14bn increase in net debt. The company's ratio of debt to earnings before interest, taxes, depreciation and amortisation is a middling 2, but rising fast. The chief financial officer has said that, to keep its credit rating, Philip Morris "will have to bring our cash outflow in line with our inflow". That will mean reducing either buybacks or dividends - these cost $2.7bn more than the company brought in last year. If the stock did not react to this change, that would be very atypical indeed.

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