Is There An Opportunity With Philip Morris International Inc.'s (NYSE:PM) 35% Undervaluation?

Philip Morris International Inc. +2.82%

Philip Morris International Inc.

PM

93.77

+2.82%

Key Insights

  • Philip Morris International's estimated fair value is US$144 based on 2 Stage Free Cash Flow to Equity
  • Current share price of US$94.08 suggests Philip Morris International is potentially 35% undervalued
  • Our fair value estimate is 33% higher than Philip Morris International's analyst price target of US$109

Does the December share price for Philip Morris International Inc. (NYSE:PM) reflect what it's really worth? Today, we will estimate the stock's intrinsic value by projecting its future cash flows and then discounting them to today's value. We will take advantage of the Discounted Cash Flow (DCF) model for this purpose. Believe it or not, it's not too difficult to follow, as you'll see from our example!

Remember though, that there are many ways to estimate a company's value, and a DCF is just one method. If you want to learn more about discounted cash flow, the rationale behind this calculation can be read in detail in the Simply Wall St analysis model.

View our latest analysis for Philip Morris International

Is Philip Morris International Fairly Valued?

We use what is known as a 2-stage model, which simply means we have two different periods of growth rates for the company's cash flows. Generally the first stage is higher growth, and the second stage is a lower growth phase. To begin with, we have to get estimates of the next ten years of cash flows. Where possible we use analyst estimates, but when these aren't available we extrapolate the previous free cash flow (FCF) from the last estimate or reported value. We assume companies with shrinking free cash flow will slow their rate of shrinkage, and that companies with growing free cash flow will see their growth rate slow, over this period. We do this to reflect that growth tends to slow more in the early years than it does in later years.

A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, and so the sum of these future cash flows is then discounted to today's value:

10-year free cash flow (FCF) forecast

2024 2025 2026 2027 2028 2029 2030 2031 2032 2033
Levered FCF ($, Millions) US$10.3b US$10.8b US$11.5b US$11.9b US$12.2b US$12.5b US$12.8b US$13.2b US$13.5b US$13.8b
Growth Rate Estimate Source Analyst x5 Analyst x4 Analyst x1 Analyst x1 Est @ 2.78% Est @ 2.61% Est @ 2.50% Est @ 2.41% Est @ 2.36% Est @ 2.31%
Present Value ($, Millions) Discounted @ 7.2% US$9.6k US$9.4k US$9.3k US$9.0k US$8.6k US$8.2k US$7.9k US$7.5k US$7.2k US$6.9k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$84b

After calculating the present value of future cash flows in the initial 10-year period, we need to calculate the Terminal Value, which accounts for all future cash flows beyond the first stage. The Gordon Growth formula is used to calculate Terminal Value at a future annual growth rate equal to the 5-year average of the 10-year government bond yield of 2.2%. We discount the terminal cash flows to today's value at a cost of equity of 7.2%.

Terminal Value (TV)= FCF2033 × (1 + g) ÷ (r – g) = US$14b× (1 + 2.2%) ÷ (7.2%– 2.2%) = US$282b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$282b÷ ( 1 + 7.2%)10= US$140b

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is US$224b. The last step is to then divide the equity value by the number of shares outstanding. Relative to the current share price of US$94.1, the company appears quite undervalued at a 35% discount to where the stock price trades currently. The assumptions in any calculation have a big impact on the valuation, so it is better to view this as a rough estimate, not precise down to the last cent.

dcf
NYSE:PM Discounted Cash Flow December 29th 2023

Important Assumptions

The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the cash flows. Part of investing is coming up with your own evaluation of a company's future performance, so try the calculation yourself and check your own assumptions. The DCF also does not consider the possible cyclicality of an industry, or a company's future capital requirements, so it does not give a full picture of a company's potential performance. Given that we are looking at Philip Morris International as potential shareholders, the cost of equity is used as the discount rate, rather than the cost of capital (or weighted average cost of capital, WACC) which accounts for debt. In this calculation we've used 7.2%, which is based on a levered beta of 0.999. Beta is a measure of a stock's volatility, compared to the market as a whole. We get our beta from the industry average beta of globally comparable companies, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable business.

SWOT Analysis for Philip Morris International

Strength
  • Debt is well covered by earnings.
  • Dividend is in the top 25% of dividend payers in the market.
Weakness
  • Earnings declined over the past year.
Opportunity
  • Annual earnings are forecast to grow for the next 3 years.
  • Good value based on P/E ratio and estimated fair value.
Threat
  • Debt is not well covered by operating cash flow.
  • Total liabilities exceed total assets, which raises the risk of financial distress.
  • Dividends are not covered by earnings and cashflows.
  • Annual earnings are forecast to grow slower than the American market.

Moving On:

Although the valuation of a company is important, it is only one of many factors that you need to assess for a company. The DCF model is not a perfect stock valuation tool. Rather it should be seen as a guide to "what assumptions need to be true for this stock to be under/overvalued?" If a company grows at a different rate, or if its cost of equity or risk free rate changes sharply, the output can look very different. Why is the intrinsic value higher than the current share price? For Philip Morris International, we've compiled three relevant elements you should further examine:

  1. Risks: You should be aware of the 2 warning signs for Philip Morris International we've uncovered before considering an investment in the company.
  2. Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for PM's future outlook? Check out our management and board analysis with insights on CEO compensation and governance factors.
  3. Other Solid Businesses: Low debt, high returns on equity and good past performance are fundamental to a strong business. Why not explore our interactive list of stocks with solid business fundamentals to see if there are other companies you may not have considered!

PS. The Simply Wall St app conducts a discounted cash flow valuation for every stock on the NYSE every day. If you want to find the calculation for other stocks just search here.

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