OK, so Philip Morris basically saw the debt world begin to implode in 2008. So what did it do, hunker down and go conservative? Naw. It leveraged up! It began borrowing money in order to reward shareholders (cough cough top management) with unearned buybacks and dividends. So now look at its debt to cash position:
| Balance Sheet | |
| Total Cash (mrq): | 1.82B |
| Total Cash Per Share (mrq): | 1.16 |
| Total Debt (mrq): | 29.68B |
Does this look like a good idea? Borrowing money so that your business is leverage debt:cash 15:1 not in order to expand operations but rather to buy back stock and pay dividends? Folks, this is what CEOs do when they are winding a company down! They gut the sucker and leave nothing but a shell company with no forward prospects and tons of debt. The article says that all earnings increases over the past several years have been due to price increases in the face of flat sales. In other words, the younger generation is not smoking at the rate that the boomers did. Philip Morris sees this tidal change happening. They were not allowed to market to young minds sufficiently during the formative years and so they lost a whole generation of addicts.
Philip Morris is screwed and management knows it. They are going to have to stop using debt to pump up their stock just when the market is entering a down turn. I sense that a trap door is about to open for PM shares.
12 comments:
1/15/16 $40 strike right now max $0.40 per contract? Or is the $55 or $60 strike a safer & better bet? Thanks,
~J.T.
JT, I think you are a bit early on this one. Let the DJIA prove that it has actually reversed course before committing to LT options on this IMO. A drop below the lower rail at 16700 would do it. This bull is very weak but until it falls to its knees you should measure your puts carefully.
"This is what CEOs do when they are winding a company down!" Nay, this is what CEOs do when they are pillaging a company up, siphoning whatever value, cash or options bought back through leverage, is left into their pockets.
What is the significance of 15:1 debt:cash? I don't think that metric matters at all.
They generate $8.5bn of cash flow every year which could pay down their debt in 3 years if they chose. Would that be more or less prudent use of shareholder money?
First, thank you for your comment. I think a lot of people are similarly misguided and so that is exactly the kind of question I like to see from readers.
"Debt doesn't matter". This is what the con men tell us while the credit portion of the money supply is expanding and they have easy access to cheap credit. It's not just corporations. Government con men do the same thing.
But when sales drop off precipitously during a depression (no, people who are having trouble paying their water bill (http://www.wnd.com/2014/06/u-n-to-intervene-in-detroit-water-shutoffs/) do not very many smoke $5-$7/pack cigs), the cash flow collapses and all that is left is the debt.
It is one thing to take on debt in order to increase production. It is almost even forgivable if a CEO does this into the jaws of a greater depression because he forgot about this little thing call the credit cycle. But taking on debt in order to pay dividends and do stock buybacks just because the interest rates are low??? That is a known and obvious end game scam.
What happens when those rates begin to rise and you have to roll that debt over because your cash flow has dried up like Lake Mead? Yeah, that's right, the debt service skyrockets and those numbers that you quote for free cash flow become tiny specs in rear view mirror. You do realize that the global economy almost collapsed in 2007, don't you? You do remember that nobody would loan any money to anyone, not even bank to bank there for awhile, don't you? What happens when that 14 billion has to be rolled over at 7,8,9,10, 15%? You do recall that Volcker had to raise interest rates on GOVERNMENT debt to 13+% back in the 70s, don't you? Have all these lessons been forgotten? Have we reached a permanent plateau of ponzi prosperity whereby we no longer have to worry about the dangers of having lots of debt and no cash? I think not. And if it were any time but right now I would not be so vocal about it. But interest rates are going up and it they will go up higher than most people think is possible. Those with lots of debt and little cash have no shelter from the coming shitstorm.
Debt should be a safety buffer, used in times of emergency, not as a matter of course to make sure that the fat cat CxOs get paid extra well even though they were unable to increase sales volumes.
Keep lurking, Mr. Anonymous, and let's have this chat again in 12-18 months.
I didn't say debt didn't matter, I said the debt:cash ratio doesn't matter when FCF is generated in the amounts that PM does. PM has no issue servicing the debt.
Which $14bn, as you mention, will need to be rolled over? They have $13bn due before 2020, which they could pay off by 2015 if they wanted to. All on fixed interest rates.
Also, just want to clarify PM does not sell cigarettes in Detroit, it doesn't really matter what happens to their water bill.
Again with the "they can make the monthly payment the way things stand today" argument? Really? We are headed into a depression that will likely rival or beat the great depression. The reason for it today is the same as back then: too much debt. This whole idea that things will stay the same way forever so we can just live right up to the hilt is folly when it comes to running one's life and one's business.
I have a good job. It pays quite well. I could buy a much larger home, new vehicles and plenty of toys right now if I just financed them. I would have no problem making the monthly payment and could easily pay them off early if nothing changes from today. But I know that good jobs will not always be easy to come by and that layoffs happen so I avoid charging up big debt that would only be used to consume more today.
Of course if I knew that I were sick with terminal disease, that would certainly change. I would charge up a storm, live beyond my means and not worry about the size the debt. Have a look at the chart of cigarette smoking:
http://wholehealthsource.blogspot.com/2012/02/cigarette-smoking-another-factor-in.html. Smokers are a dying breed. The whole concept of smoking seems terminal. Perhaps that's why management is racking up debt in order to pay dividends.
I guess you didn't really understand the gravity of what happened back in 2007-2008 or the lengths to which the powers that be had to go in order to prop up the economy. They won't be able to do it again.
One more thing not related to the debt, but is just the kind of curve ball that people don't see coming: as governments get desperate they begin to eat their own. Right now governments are taking money from the banks. For example,$9 billion from BNP just today.
As the economic crisis expands the government will target any private property that they can get away with. Since cigs are no longer popular (worse yet, most people can't stand to be around them at all), they are an easy target for vilification. All the government has to do is assign additional special taxes in order to pay for the damage to public health that PM is causing with their products. This is especially possible given the large number of sick boomers that will be materializing soon. Again, I admit that this has zero to do with their cash to debt but it could affect their free cash flow.
Of course we are both speculating here. I'm speculating that debt everywhere is about to blow up in our faces. You are speculating that it won't matter to PMs free cash flow and that rising interest rates will never matter to them. Time will tell who is right. But in any case I think we can both agree that owing the shares is a bad idea right now.
http://seekingalpha.com/article/2291865-philip-morris-time-to-start-worrying
Just like you and I, servicing the debt is what bankrupts companies. I don't know how much servicing the debt costs PM, but let's assume that it's $2B a year. Today, the expense to income ratio is 1:4. Come a depression, this ratio could easily become 1:2 and then lenders would be wary of lending even for operational expenses, suppliers might demand cash for their products and services. It's not far reaching to suppose that PM's income would then shrink even more and the above ratio could approach 1:1 or worse, effectively bankrupting it in, say, less than 3 years. Corporate history has plenty of such examples, no one can say that this time is different it that one could not see this coming.
Agree and I will ad that the biggest mistake most investors make is to ignore how debt was used to buy the current situation, whatever that may be. For example:
- You neighbor has new house, car, boat and airplane. Is he rich or is he just able to make the monthly payment on all of these toys for now? Will he get laid off leaving the repo man to take away his lifestyle?
- USA has bigger everything than everyone else. Did we earn it or just borrow it? Look at Detriot (sic). It used to be one of the most productive cities in the world. Clearly they borrowed it and did not own it because now it is a complete shithole where many can't pay their water bill because there are no low-skill manufacturing jobs.
- Toyota. Everyone thinks it is a great manufacturing company but I know that 162 billion debt (and growing vs only 33 bn cash, they did not work to earn that manufacturing capacity. They borrowed it. And when you borrow to buy things the repo man will come calling the first time the economy turns down hard. I think the Japanese government has been propping them up but soon they will not be able to afford to take on more debt either.
The list goes on and on. Those who borrow excessively from tomorrow in order to consume more than they earned today will eventually wind up living on the street somewhere.
PM does not sell cigarettes in the United States, they sell only overseas. The chart you mention, and the Detroit water bill issue, is irrelevant with the caveat that eventually world smoking trends will likely match that of the US. The international trend is not yet as far advanced as the US, though, as anyone who has been to Europe/Japan/China/Africa can attest.
Governments already tax PM's revenues, the trend there is established over 20 years. It doesn't affect PMs profits, if anything it allows them to raise prices easier.
Finally, if 2007-2008 happens again, look at PM's FCF that year. Worse case scenario at least in terms of what we can see. If you want to call a scenario worse than that I'm not sure where to put money other than gold and guns, and I'm not a good enough shot to protect my gold in that situation anyway.
To get back to the original comment, though, debt with fixed interest rates amply covered by worse case cash flow in one of the most resilient industries known to modern industry is not an experiment in folly, in my opinion, its good financial management.
See you in 18 months.
Augustine: Interest is $1bn a year. Just to clarify, $8bn in FCF is after interest expense and taxes. Lenders use the Interest to EBITDA ratio to determine lending capacity; EBITDA is $14bn. In this case, Philip Morris covers its interest expense in about 20 days of operations...the rest of the year is profits (before tax). Even if they went back to the lowest EBITDA in the past decade for some reason, 2004, that was still almost 7x coverage. Its not like they're just squeezing by.
PM was smart to borrow money when rates are so low. All shareholders benefited (including top management, as it should be).
Captain, not sure where you get your Toyota numbers. They have about $80bn in debt vs. $152bn in equity and are one of the more conservatively managed car companies around.
From Yahoo/Capital IQ on TM:
Balance Sheet
Total Cash (mrq): 33.32B
Total Cash Per Share (mrq): 21.03
Total Debt (mrq): 162.30B
Total Debt/Equity (mrq): 108.38
Current Ratio (mrq): 1.07
Book Value Per Share (mrq): 89.83
BTW, who really knows what the truth is about these numbers. If a major Japanese company was hiding financial problems you will see it in the chart, not on the balance sheet. The chart knows everything and TM is sporting a massive declining double top.
Post a Comment