Investment Thesis
I believe Philip Morris International (NYSE:PM) is a compelling buy due to the continued transformative potential of Zyn, its nicotine pouch product.
I believe Zyn has demonstrated exceptional growth, particularly in the US, where its volumes surged by 80% in Q1 2024 alone. This impressive performance is attributed (in part) to its strong appeal among Gen Z, who see it as a trendy and more socially acceptable alternative to traditional smoking. The product's integration into Gen Z culture, combined with its dominance of significant market share at 74.3% in the US nicotine pouch segment, underscores its potential to drive substantial growth for Philip Morris.
Despite this rapid growth and strong market presence, PM's stock has underperformed the market since I last wrote about them, creating a disconnect between Zyn's market performance and PM's stock valuation. I believe this underperformance presents a notable opportunity for investors, as the market appears to be underappreciating Zyn's full potential. The company's favorable valuation, trading below the sector median P/E ratio, suggests upside potential as the market begins to fully recognize Zyn's value.
I believe Zyn's remarkable growth, cultural integration, and significant market share make Philip Morris an attractive investment. The potential for stock re-rating, driven by Zyn's success and market recognition, reinforces my buy (now strong buy) recommendation. Despite competitive and regulatory risks, Zyn's strong brand equity for the right group, and market leadership among non-smoke alternatives allow Philip Morris as a whole to well navigate these challenges and contribute to Philip Morris' strategic shift towards a smoke-free future.
Why I Am Doing Follow-Up Coverage
In November, I wrote an article advocating for Philip Morris as a buy due to Zyn's potential, specifically highlighting its growth prospects and market adoption. At that time, Philip Morris had recently acquired Swedish Match (less than a year before), integrating Zyn (one of their tobacco-less products) into its portfolio. The acquisition was expected to boost PM's presence in the nicotine pouch market, a segment experiencing rapid growth.
Despite the optimistic outlook, PM's stock has underperformed the market (see below). This lag in performance comes even as Zyn's growth has accelerated (when I wrote about Zyn in November volumes were growing 66% YoY in the US, they are now growing at 80%). In the initial article, I pointed out that Zyn's appeal to younger demographics, particularly Gen Z, could be a game-changer. This demographic shift is now becoming more evident, with Zyn gaining traction among Gen Z users who see it as a trendy and socially acceptable alternative to traditional smoking.
I find Zyn's integration into Gen Z culture is fascinating, with the product being widely discussed on social media platforms. It is even being compared as an Ozempic (the popular GLP-1 weight loss drug) alternative given nicotine's known capabilities as an appetite suppressant, highlighting its cultural penetration.
With this, the market appears to be under-appreciating Zyn's full potential. The product's accelerating growth and increasing market share are not fully reflected in Philip Morris stock price (especially given how fast the company is growing as compared to other consumer staples & their 5-year average).
I believe this oversight presents a significant opportunity for investors. Zyn's continued success and its acceptance among younger consumers could drive substantial growth for Philip Morris & why I think the stock a compelling strong buy. I’m covering Philip Morris because even though the story has become more bullish, I believe the market has not rewarded that yet.
The Results Speak For Themselves
Philip Morris' Q1 2024 earnings report showed this strong performance, driven by robust volume growth across its product portfolio. The company's revenue for Q1 2024 reached $8.79 billion, marking a 9.65% year-over-year increase and exceeding expectations by $340.78 million.
This impressive performance is largely attributed to the explosive growth of Zyn, the nicotine pouch product that has taken the market by storm.
Zyn's US volumes surged by 80% during Q1 2024, a remarkable feat in the nicotine product category, where such high-demand growth is uncommon (Q1 Call).
This growth underscores Zyn's strong market acceptance and the increasing consumer shift towards smokeless nicotine products. The product's rapid adoption and high demand have led to instances of product shortages in various regions, highlighting its popularity and the challenges in meeting the burgeoning demand.
The exceptional performance of Zyn is reflected in Philip Morris' overall growth metrics. The company's smoke-free products, including Zyn, contributed significantly to the double-digit growth in organic net revenue and operating income. Specifically, smoke-free net revenues grew by 25%, and gross profit from these products increased by 38% (Q1 Call).
This substantial growth in the smoke-free segment, particularly Zyn, has been a key driver in Philip Morris' transformation strategy towards a smoke-free future.
With this, Zyn's market dominance is evident from its growing market share. The product now holds a 74.3% share of the US nicotine pouch market, an increase of 6.9 percentage points year-on-year. Get this: market share is expanding. Multiple companies are trying to go for this vertical and yet even after it has become more discovered, their core product is continuing to excel. I think this is key evidence that they have something unique.
Keep in mind as well (from the call): “...[this] increase of plus 6.9 points year-on-year and 1.3 points sequentially [came] despite a $0.15 cent per can price increase in March. Retail value share also grew to 79.3%, highlighting ZYN's premium positioning and superior brand equity. -Q1 Call
Valuation
In my opinion, Philip Morris' valuation, when compared to the consumer staples sector, is super favorable. Despite Zyn driving significant revenue and EPS growth, Philip Morris' forward GAAP P/E ratio remains below the sector median (at 16.52 vs. 19.64 for the sector as a whole). All the while (as I mentioned above) revenue growth is at 12.21% YoY. I believe this suggests potential for the stock to converge towards the sector median P/E, indicating substantial upside. If we see the company’s forward P/E converge on the sector median, this would imply 18.88% upside in their stock price. This would imply a fair value of $118.39/share.
From a peer perspective, the main reason I think the company deserves to trade at a higher P/E valuation from where they are today is because of their growth.
While competitors such as Altria Group (MO) has had revenue growth of 10.66% growth YoY, and British Tobacco Group (BTI) had revenue growth of -1.35% YoY, Philip Morris stands out well above the pact. Their revenue growth was 12.21% YoY, with forward revenue growth estimates of 7.29% being 88.09% higher than the sector median of 3.88% YoY revenue growth.
Where This Fits In With Previous Valuation Estimates
In my previous article, (at that time), Philip Morris was trading at 14.94 times forward earnings, compared to a sector median of 17.21 times earnings. This indicated a relative undervaluation, suggesting that the market had not fully priced in the growth potential of Zyn. In my last research piece, I implied that Philip Morris could have 45% upside from share prices at the time. Since then, shares are up roughly 10.79% including dividends.
To be clear, I see this as a long run price target still (so using simple math, shares still have roughly 35% more upside from the original price shares were at in November). The purpose of this article is to go over where I think shares could go in the more short term (next 12 months or so).
Given this, I think it is key to compare the 1-year FWD P/E ratio for Philip Morris compared to the sector median to understand where we could see the stock go over a more short term (12 months) given the relative comparisons in P/E. Given this, I arrived at 19.43% upside in the more short run.
Risks
While competition exists from other nicotine pouch manufacturers, Zyn's current market dominance and growth trajectory suggest it is well-positioned to fend off disruptors. The primary risk is the entry of new competitors or potential regulatory changes. However, Zyn's strong brand equity and market presence mitigate these risks.
The nicotine pouch market is becoming increasingly competitive, with several major players, including Swedish Match (Zyn -now owned by Philip Morris) and British American Tobacco (LYFT) actively expanding their product lines and market reach.
Despite this, Zyn holds a significant market share, particularly in the U.S., where it commands a 74.3% share of the nicotine pouch market. Its robust growth and strong market presence provide a substantial competitive edge. Additionally, Zyn's popularity among younger demographics, driven by its variety of flavors and discreet usage, continues to attract a loyal customer base. I think these flavors and discreet usage allows them to play to the same consumer psyche we saw with Juuls that were a big trend among Gen Z a few years ago.
Disclaimer: To be clear, I am not arguing for underage nicotine purchases. Rather this article is going over the investment potential of Philip Morris given the market penetration and success among over 21 Gen-Z consumers. Please keep in mind when reading this that many Gen-Z customers are currently under 21 which is the age to purchase nicotine products in the US.
With this, there is obviously government regulation risks with selling products geared towards younger generations (and is clearly picking up traction among younger generations). However, what is unique about Zyn pouches (and other nicotine pouch products) is that they are much harder to trace to medical conditions. While smoking has a clear casual relationship with lung cancer and tobacco pouches have been shown to cause mouth cancer, Zyn pouches have been found to be much safer (there are still some risks like cardiovascular disease).
With this, because the health effects are less traceable, I believe the risks of federal regulations and fines are much lower.
Bottom Line
I believe Zyn's exceptional growth and market penetration make Philip Morris a compelling investment. The product's appeal to Gen Z, cultural integration, and significant market share underscore its potential to continue to be a transformative asset for Philip Morris. Despite the stock's underperformance relative to the market, Zyn's rapid adoption and increasing dominance present a unique opportunity for investors.
The Q1 2024 earnings report highlights Zyn's continued substantial contribution to Philip Morris' overall financial performance, with notable revenue and profit growth driven by the product's success, even exceeding what we saw last time I wrote on Philip Morris. Zyn's market share now stands at an impressive 74.3% in the U.S. nicotine pouch market, reflecting its strong brand equity and consumer acceptance.
A re-evaluation of the forward P/E ratio, considering Zyn's performance, suggests substantial short term (1 year) upside potential as the market begins to fully recognize the product's value.
While competition and risks exist, Zyn's robust growth trajectory and market leadership position it well to navigate these challenges. The continued success of Zyn, particularly among younger demographics, reinforces Philip Morris' strategic shift towards a smoke-free future and solidifies its standing as a strong buy in the current market environment. I think it's a strong buy.
Noah's Arc Capital Management
This account is managed by Noah's Arc Capital Management. Our goal is provide Wall Street level insights to main street investors. Our research focus is mainly on 20th century stocks (old economy) undergoing a 21st century transformation, but occasionally we'll write on companies that help transform 20th century firms as well. We look for innovations in a business model that will cause a stock to change dramatically. Associated with SA contributors Thomas Potter and Elijah Buell.
Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Noah Cox (account author) is the managing partner of Noah’s Arc Capital Management. His views in this article are not necessarily reflective of the firms. Nothing contained in this note is intended as investment advice. It is solely for informational purposes. Invest at your own risk.
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