Philip Morris International Inc. (NYSE:PM) Shares Could Be 34% Below Their Intrinsic Value Estimate
Key Insights
Philip Morris International's estimated fair value is US$145 based on 2 Stage Free Cash Flow to Equity
Philip Morris International is estimated to be 34% undervalued based on current share price of US$95.12
The US$113 analyst price target for PM is 22% less than our estimate of fair value
Today we'll do a simple run through of a valuation method used to estimate the attractiveness of Philip Morris International Inc. (NYSE:PM) as an investment opportunity by estimating the company's future cash flows and discounting them to their present value. We will take advantage of the Discounted Cash Flow (DCF) model for this purpose. Believe it or not, it's not too difficult to follow, as you'll see from our example!
Remember though, that there are many ways to estimate a company's value, and a DCF is just one method. If you still have some burning questions about this type of valuation, take a look at the Simply Wall St analysis model.
View our latest analysis for Philip Morris International
Step By Step Through The Calculation
We use what is known as a 2-stage model, which simply means we have two different periods of growth rates for the company's cash flows. Generally the first stage is higher growth, and the second stage is a lower growth phase. To begin with, we have to get estimates of the next ten years of cash flows. Where possible we use analyst estimates, but when these aren't available we extrapolate the previous free cash flow (FCF) from the last estimate or reported value. We assume companies with shrinking free cash flow will slow their rate of shrinkage, and that companies with growing free cash flow will see their growth rate slow, over this period. We do this to reflect that growth tends to slow more in the early years than it does in later years.
Generally we assume that a dollar today is more valuable than a dollar in the future, and so the sum of these future cash flows is then discounted to today's value:
10-year free cash flow (FCF) forecast
2023 | 2024 | 2025 | 2026 | 2027 | 2028 | 2029 | 2030 | 2031 | 2032 | |
Levered FCF ($, Millions) | US$9.54b | US$10.8b | US$11.6b | US$12.3b | US$12.8b | US$13.3b | US$13.8b | US$14.2b | US$14.6b | US$14.9b |
Growth Rate Estimate Source | Analyst x6 | Analyst x6 | Analyst x5 | Est @ 5.58% | Est @ 4.54% | Est @ 3.81% | Est @ 3.30% | Est @ 2.94% | Est @ 2.69% | Est @ 2.52% |
Present Value ($, Millions) Discounted @ 7.5% | US$8.9k | US$9.3k | US$9.4k | US$9.2k | US$9.0k | US$8.7k | US$8.3k | US$8.0k | US$7.6k | US$7.3k |
("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$86b
We now need to calculate the Terminal Value, which accounts for all the future cash flows after this ten year period. 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 2.1%. We discount the terminal cash flows to today's value at a cost of equity of 7.5%.
Terminal Value (TV)= FCF2032 × (1 + g) ÷ (r – g) = US$15b× (1 + 2.1%) ÷ (7.5%– 2.1%) = US$285b
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$285b÷ ( 1 + 7.5%)10= US$139b
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$225b. In the final step we divide the equity value by the number of shares outstanding. Compared to the current share price of US$95.1, the company appears quite good value at a 34% discount to where the stock price trades currently. Remember though, that this is just an approximate valuation, and like any complex formula - garbage in, garbage out.
The Assumptions
Now the most important inputs to a discounted cash flow are the discount rate, and of course, the actual cash flows. You don't have to agree with these inputs, I recommend redoing the calculations yourself and playing with them. 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 7.5%, which is based on a levered beta of 0.899. 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:
Valuation is only one side of the coin in terms of building your investment thesis, and it shouldn't be the only metric you look at when researching a company. The DCF model is not a perfect stock valuation tool. Instead the best use for a DCF model is to test certain assumptions and theories to see if they would lead to the company being undervalued or overvalued. For instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. Why is the intrinsic value higher than the current share price? For Philip Morris International, we've compiled three additional factors you should further examine:
Risks: Be aware that Philip Morris International is showing 3 warning signs in our investment analysis , and 2 of those are significant...
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.
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. Simply Wall St updates its DCF calculation for every American stock every day, so if you want to find the intrinsic value of any other stock just search here.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
Join A Paid User Research Session
You’ll receive a US$30 Amazon Gift card for 1 hour of your time while helping us build better investing tools for the individual investors like yourself. Sign up here
