The World Health Organization recently estimated that over 4 million people are killed every year because of smoking-related diseases. The death of those 4 million is a horrible thing and something that none of us should take lightly. However, the truth remains that the majority of those people smoked for years because it was a legal choice and for one reason or another they wanted to.
Smokers need to claim responsibility for engaging in a well-known risky behavior. Long before the federal government mandated a warning label on cigarettes the health risks linked with smoking were widely recognized. In fact, the tobacco lobby would be quick to point out that the head of the American Medical Association wrote in 1966 that a warning label on cigarettes was unnecessary because the health risks associated with smoking were well known.
Smoking is harmful and everyone who has ever taken a puff would be double-dealing if they told you otherwise. I don't condone any misleading or pseudo science from Philip Morris. They should be held accountable for any illegal activities. Nevertheless, a question of personal responsibility always looms in my mind when I think of Big Tobacco. (WOW, I hope I was able to get through that without offending anyone!)
I initially felt an urge, almost out of tradition, to make a valuation argument on why Philip Morris is such a great investment. I spent some time doing a discounted cash flow analysis and had this great argument composed of how the company's earnings don't support its price. I could have told you that the food division could be valued anywhere between $30-$45 per share and left this Duel feeling proud of my sound argument. Unfortunately, that would only be restating what has been said before and we wouldn't leave this exercise any better off.
I think Bill would concede that the company's earnings, margins, dividend, share buyback program, and ungodly cash flows are all quite impressive, particularly in comparison to other Dow Industrial stocks. The question that we are all compelled to answer is one of risk. Meaning, does the beaten down stock price effectively depict the future, particularly in the legal arena, of this company?
Legal woes are overcooked
Bill's argument is as predictable as addiction. In the few discussions we've had about the company, he's gone on how the legal troubles are never-ending. Bill preaches, "Despite their broad diversification of business brands, their legal troubles will never end." Unfortunately, his argument is big on shock value and little on substance.
The litigation concerns are clearly overblown. Bill and the anti-tobacco media enjoy talking about how the judgments will break the company. However, the facts don't represent such assertions. No one ever mentions that the industry has won 12 of 15 of the tobacco trials since 1996. The three losses are all on appeal and an 80% success rate would be the envy of any industry. Moreover, it's evidence that the personal responsibility issue alluded to earlier is an effective form of legal defense.
It's also important to remember that the $74 billion Philip Morris is responsible for in the Florida trial will certainly be reduced and probably thrown out of court. The worst case scenario is that the company would pay a substantial portion of the damages, however, it's yet to pay a dime in any other judgment. True, there was the settlement with the 46 states for $100 billion, but that was nothing more than dust in the wind. The settlement will easily be paid for over the next 25 years with the raising of cigarette prices.
LouAnn Lofton (TMFLou2) expanded on the subject when she broke down the litigation concerns for Philip Morris going forward. She noted that there are between 500,000 and 700,000 members of the class action in Florida and each will have their compensation claims heard individually. The process will take an eternity to complete and Philip Morris won't pay anything for years.
There's also the issue of class-action suits and the unconstitutional basis upon which they stand. Lou added that 25 states and federal courts have thrown out similar cases like the one in Florida. The courts no longer look favorably upon class-action lawsuits against Big Tobacco because it's unfair to group people together with different illnesses. If on November 7 the Florida trial is moved to the tobacco-friendly federal court, the case will almost certainly be dismissed. The decision should send a clear signal to overzealous attorneys: class-action lawsuits are full of ash.
Where to from here?
At this point, people are probably beginning to think I am crazy. After all, I haven't even mentioned the Nabisco acquisition, last week's dividend increase of 10.4%, or the Kraft IPO next year. Rest assured, these are all reasons to invest in the company, but a Philip Morris bull doesn't have to hide behind valuation arguments and product diversification. The stock price has been accurately discounted and the legal environment is improving. That alone is reason to be bullish on this "bad boy."
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