Before changing its name back in 2003, Altria Group Inc. (NYSE: MO) used to be known as none other than Phillip Morris. It still kept the MO ticker symbol for Morris though, as a memento. The reason behind the name change is contentious, depending on whom you ask. Altria insists it was to show that its business was more than just cigarettes. Those outside the tobacco industry say it was merely a rebranding move to a name that sounds like “altruism” to deflect some of the political heat off of Big Tobacco.
Then, in 2008, Phillip Morris International Inc. (NYSE: PM) was spun off from Altria to form two separate companies. Altria would serve the U.S. tobacco market, and PMI would serve the rest of the world. By revenue, earnings and market cap, PMI is the bigger company. And since the last major bear market bottom in 2009, PMI shares have generally outperformed Altria by as much as 65%, excluding a very brief period on 2010.
By mid-2014, that all changed. Altria began pulling away, and at one point outpaced PMI shares by over 100%. Altria is still ahead by 70% from market bottom 2009. What happened?
Two things. As a small tweak of the old joke about life goes: The only two things that are certain in the corporate world are debt and taxes.
On May 19, 2014, the European Union’s Revision of the Tobacco Products Directive went into effect. This was a whole litany of new regulations to promote health (read restrict and/or ban tobacco sales) within the EU that PMI fought against tooth and nail. It won a few battles, but lost the war. Shares of PMI tanked, as did Altria’s, but not as badly. Altria recovered nicely since then. PMI did not.
Look at the earnings statements and you will get a good idea of the astronomical level of taxation on tobacco in the EU, not even counting the new market restrictions. Excise taxes on PMI products went up from 59% to 63% of total revenue from 2012 to 2014. For Altria, they went down from 29% to 26%. This is the main reason why Altria’s gross profit margins are consistently in the 40% range and slowly growing, whereas PMI’s are consistently in the mid-20s and slowly falling.
The other reason why Altria has pulled away all of a sudden is debt. In 2012 and 2013, Altria spent $4.1 billion buying back its own debt, taking a significant hit and recording a pretax loss of $2 billion in those two years. But now that early debt extinguishment is bearing fruit, as total debt has remained steady and interest expense has dropped 28% since 2012. For PMI, interest expense has increased 22% over the same period, with total debt increasing 34%.
Taken together, the divergence in debt and taxes between the two companies has drastically affected their bottom lines. For Altria, revenue is down 0.4% since 2012, but net income is up 21%, despite the lack of growth. For PMI, it is the opposite. Revenue is up 3.5%, but net income is down 15%. This means people in the EU are not smoking less tobacco due to Revision of the Tobacco Products Directive at all. Otherwise, revenue would be down. It is just that more of PMI’s revenue is going to EU governments instead of PMI shareholders.
If we contrast this with the period of 2010 to 2012, when PMI was beating out Altria, the situation was reversed. Revenue for Altria during those years was up 1% and earnings up 7%. For PMI, revenue was up 14% and earnings up 22%, which is why PMI outperformed for those years.
The situation turned 180 degrees since mid-2014, and the two companies’ stock prices show it clearly. So, debt and taxes. Pay off your debt early, and keep your taxes low, if you can. Shareholders will appreciate it. Altria’s trajectory and PMI’s languishing will continue so long as debt and taxes decrease for the former, and increase for the latter.