This is a strange research report. But coming from the weakest tobacco analyst in Bonnie Herzog, that is pretty typical. Maybe there is more analysis behind it than this summary, but based off just this, it makes little sense. It starts out by saying that she likes the long term positioning and strength of PM, but then details short term cost pressures and uncertainties, and issues a 12-month price target below the current share price.

 

I don't even disagree with the main points about earnings. I agree that IQOS looks very strong for the future, but that profits will be impacted somewhat in the next few years as they continue to invest behind it, and most importantly behind the launch in the US. She doesn't even mention four additional factors that will pressure PM profits next year. First is some further negative currency impact, particularly in the first half of 2023 until they lap the fall of the euro and yen. Second, is higher interest expense, due to interest rates rising significantly, especially on the $16 billion of debt that PM will have to issue to pay for the Swedish Match acquisition. Thirdly, they will have higher interest expense for the $2.7 billion they have to pay MO to take back US IQOS rights. And finally, I would anticipate that PM will eventually sell their Russia business sometime in 2023. While they have already removed Russia results from their "pro-forma" earnings this year, they still earned nearly a billion dollars in real money in 2022 from the Russia and Ukraine businesses that they will likely lose going forward, for which they are likely to receive very little in the way of a sales price. Those lost earnings will further pressure cash flow and interest expense.

 

At the same time, PM will obviously have zero revenues from US IQOS in 2023 as they won't even reacquire the rights until May 2024. And they will likely have losses from it in the US for a few years after launch.

 

So now, if you do what analysts are supposed to, which is try to accurately value a business, you do this: you factor ALL those impacts into your valuation. You take your estimates of all future earnings, expenses, and cash flows, and discount them all back to the present day (using NPV net present value) to determine a reasonable price today. That includes both the short term estimates of higher costs, and the longer term estimates of higher revenues and profits.

 

For example, that is what Morgan Stanley did on their recent analyst report about PM. They model in higher costs and losses for IQOS launch in the US over the next five years, along with estimates of the incremental US share gains and profits over the next 10 years. And doing that, they use a base case estimate that IQOS will capture 6% of the US cigarette market by 2030 and 10% by 2033. Factoring in losses before they reach US profitability in 2027, this base case model still results in additional positive NPV in the US of about $7 per PM share. They then use that NPV to put a current price target of $109 on PM shares.

 

Morgan Stanley also models what they consider bearish and bullish cases for IQOS in the US. The bear case assumes that IQOS essentially fails and remains a niche product, and only captures 4.5% of the US cigarette market by 2033. That model would indicate negative NPV, and leads to a current value for PM of only $75 share. The bull case is that IQOS grabs 10% US market share by 2030, and 16% by 2033, which results in a current value for PM of $141 per share. For comparison, PM management has stated that they expect IQOS to have a 10% US market share by 2030, which is what MS would consider the bullish case.

 

You can obviously decide for yourself what you think the prospects for PM in the US are, and your assumptions can obviously result in a great deal of difference in what the company is currently worth. That's the risk of investing, and it is unavoidable. For example, under Morgan Stanley's bear case, PM is currently worth $10 per share less than what Goldman estimates.

 

But what doesn't make any sense is what Goldman says here. If they actually like PM's long term position, which seems to indicate they think US IQOS is going to be a success, it makes PM worth more today, despite the near term investment needed to get it to that success. For them to put a lower 12 month price target, is simply to guess that, while the company is worth more, the share price will temporarily go down before it goes higher. Of course, that could happen. But that is not logical investing advice, but market predictions which are nothing more than random gambles.