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By: Ahmed Ishtiaq

The tobacco industry has been an extremely attractive place for dividend hunters. Massive market size and huge piles of cash make it possible for companies in the sector to hand out regular dividend payments. As a result, this sector has been one of the most consistent dividend payers over the years. The companies in the tobacco sector were able to do well even in times of economic slowdown. However, more recently, strict regulations have hampered the sales and restricted the growth in the industry. It should be kept in mind that Tobacco industry is in its mature stage, and any growth is likely to be marginal. Nevertheless, the participants have incredibly strong market position and continue to pay their investors handsomely.

We decided to choose three companies with attractive dividend yields, and enough free cash flows to maintain their dividends. We believe that these companies will continue to pay the current levels of dividends.

Phillip Morris International

Philip Morris International Inc. (NYSE:PM) is the leading international tobacco company, with seven of the world's top 15 international brands, including Marlboro, the number one cigarette brand worldwide. PMI's products are sold in approximately 180 countries. Philip Morris has a rich history of steady cash dividends. The company has a dividend yield of 3.83% and annualized dividend of $3.40 per share. Philip Morris revenues have increased by more than 38% in the previous five years. This represents an exceptional growth in revenues for a company operating in a mature and stable industry.

Moreover, the firm has been able to generate an impressive operating margin of between 16% and 17.6% in the previous five years. An increasing trend in revenues and operating margin is backed by an incredible increase in the EPS from the levels of 2007. Philip Morris earnings per share have experienced a massive increase of 69.5% in the previous five years. For the most recent quarter, the company reported earnings of $1.38 per share and year-over-year growth of 8.1%.

Philip Morris has incredibly strong cash flows. The company has been able to increase its cash flows each year, over the past five years. At the end of 2011, the company generated $10.5 billion in cash flows from operations and $9.6 billion in free cash flows. Moreover, for the trailing twelve months, the company generated $8.73 billion in operating cash flows and $7.6 billion in free cash flows. Dividends paid during the past twelve months were $5.3 billion, which puts the payout ratio at around 70%. Phillip Morris dividends are adequately covered with its free cash flows.

Reynolds American International

Reynolds American (NYSE:RAI) controls roughly 28% of the U.S. cigarette market and is the second-largest domestic cigarette manufacturer behind Altria. Its brands include Camel, Kool, and Pall Mall. At the moment, the company pays an annual dividend of $2.36 per share, yielding 5.54%. The company has fairly stable levels of revenues. During the past four years, RAI has reported revenues around $8.5 billion. It is fair to say that the growth has been somewhat stagnant for the company. In the past twelve months, it has been able to generate $8.3 billion in sales, again indicating slow growth.

However, the cash flows have been growing at an impressive rate for the company. Over the past two years, cash flows from operations have grown at an average of 8.6%. At the end of 2010, the company generated $1.2 billion in operating cash flows, which has grown to $1.49 billion during the past twelve months. Payout ratio based on free cash flows go close to hundred percent for the company. Trailing twelve months payout ratio stands at around 93%. It generated $1.383 billion in free cash flows and paid $1.286 billion in cash dividends over the past twelve months. Although the payout ratio is incredibly high, stable revenues should enable the company to generate enough cash for dividends.

Lorillard, Inc

Lorillard (NYSE:LO) is the third-largest manufacturer of cigarettes in the United States. Its flagship brand, Newport claims a 14% share of the total U.S. cigarette market, and a 36% share of the menthol category. Lorillard pays an annual dividend of $6.20 per share, yielding 5.10%. Like its peer Philip Morris, the company has shown impressive revenue growth over the past three years. Lorillard revenues have grown at an average of 15.6% during the past three years. In a mature industry, this growth rate is particularly exciting. In the past twelve months, the company recorded revenues of $6.5 billion and operating income of $1.88 billion.

On the other hand, Lorillard has healthy cash flows. The company generated $1.132 billion in cash flows from operations over the past twelve months, and $1.058 billion in free cash flows. Meanwhile, the company paid $781 million in cash dividends. Payout ratio for Lorillard based on free cash flows is around 74%. Recently, the company acquired blu e-cigs to gain entrance into the electronic cigarette category. Steps like this will ensure the company carries on with its impressive growth. I am confident that Lorillard will be able to maintain its dividends.

Summary:

The tobacco industry faces stagnant growth and threat of declining revenues due to strict regulations. However, these companies have been able to fight the tough conditions and produce impressive returns for investors. These stocks have a special pull for income investors due to high yields and solid businesses. According to my analysis, these companies should not face any trouble paying dividends. At the moment, big players in the industry are considering an increase in the prices. Philip Morris usually takes the step and then smaller players like Lorillard and Reynolds American follow. Tobacco industry will carry on its habit of high dividends and investors will keep enjoying high yields.

Source: 3 Tobacco Giants For High Dividend Yields