Philip Morris International (PM) is one of the strongest businesses in our consumer defensive coverage. The company generates industry-leading normalised operating margins in the low- to mid-40% range and boasts a wide economic moat with strong brand loyalty and cost advantages at its core. Nevertheless, we see room for execution improvement and we think margins could go even higher.
Philip Morris' profitability in emerging markets is a key differentiator against its competitors, and it has a strong presence in Asia. The advantage of selling in emerging markets is that volumes are more stable, and in some cases, increasing. Indonesia where Philip Morris has about a 31% share, Turkey where it is 45%, and the Philippines with a 90% share are all growing in volume at a low- to mid-single-digit rate as a more lax regulatory environment in those regions has led to higher levels of smoking initiation. This should help to slow the firm's decline in volumes over the next decade. The disadvantage of emerging markets is that on the whole, they are less profitable than developed markets.
This is less true for Philip Morris International than it is for its competitors. It generated a 2013 earnings before tax (EBIT) margin of 43% in Asia, only modestly below the 44% group EBIT margin and 300 basis points above that of British American. The Asia segment margin is skewed by the firm's strong presence in the profitable Japanese market, but it also reflects Philip Morris' positioning in premium categories.
After a solid third quarter that slightly surprised on the upside, we are maintaining our $90 fair value estimate for Philip Morris. Our valuation implies a 2015 P/E multiple of 18.5 times and a 2015 EV/EBITDA multiple of 12.9 times. It also implies a 2015 dividend yield of 4%, which is around the middle of the pack for the international tobacco manufacturers.
An opportunity for margin expansion lies in improving its operational efficiency, and we would like to see management focus on optimising its manufacturing processes. Since its creation in 2008, the firm has consistently operated with less efficient asset turnover and cash conversion ratios than its competitors, despite its greater scale.
We believe there is some fat to trim in the firm's cost structure, including consolidating manufacturing plants, which by bringing the firm's asset turnover ratios in line with competitors, we estimate could add a further $800 million or 200 basis points to the EBIT margin.
