In today's environment of low interest rates, investors are left looking elsewhere for decent returns on their money. One of the consistently highest yielding sectors in the market is tobacco. With the average tobacco yield now around 5%, how sustainable are these yields? The business of tobacco is no longer what it used to be, with opinions changing and companies seeing falling volumes. However, companies are still raising shareholder returns.
How sustainable are these returns for the long term and can small and large investors rely on these firms to keep the cash flowing?
1. Lorillard (NYSE:LO)
Overview
| 2012 EST. | ||||
| Share price | EPS | Dividend | Yield | Dividend Cover |
| $120 | $8 | $6 | 5.09% | 1.4 |
Cash Flow Statement
| $US millions | 2010 | 2011 | 9 Months to September 2012 |
| Net Operating Cash Flow | 1090 | 1180 | 641 |
| Net Investing Cash Flow | -40 | -50 | -154 |
| Cash Dividends Paid - Total | -645 | -726 | -204 |
| Repurchase of Common & Preferred Stk. | -716 | -1580 | -274 |
| Issuance of long term debt (Reduction) | 987 | 741 | 494 |
| Net Financing Cash Flow | -372 | -1560 | 16 |
| Free Cash Flow | 406 | 404 | 503 |
| Free Cash Flow ex. debt issuance | -311 | -1176 | 9 |
The overview of Lorillard looks ok. The dividend is covered but only just. Looking into the cash flow of LO the dividend payout is well covered. However, the stock buyback the company is undertaking to improve EPS, is pushing the firm to issue new debt to cover these buybacks.
2. Altria (NYSE:MO)
Overview
| 2012 EST. | ||||
| Share price | EPS | Dividend | Yield | Dividend Cover |
| $33 | $2.1 | $1.7 | 5.12% | 1.2 |
Cash Flow Statement
| Altria | |||
| $US MILLIONS | 2010 | 2011 | 9 Months to September 2012 |
| Net Operating Cash Flow | 2770 | 3610 | 2130 |
| Net Investing Cash Flow | 259 | 387 | 728 |
| 0 | |||
| Cash Dividends Paid - Total | -2960 | -3220 | -2508 |
| Repurchase of Common & Preferred Stk. | 98 | -1320 | -595 |
| Issuance of long term debt (Reduction) | 232 | 1490 | 165 |
| Net Financing Cash Flow | -2580 | -3040 | -3939 |
| Free Cash Flow | 449 | 957 | -1081 |
| Free Cash Flow ex debt issuance | 217 | -533 | -1246 |
Altria is paying out most of its EPS as dividends to shareholders. Combined with the stock repurchases, this is making the most of Altria's cash flow negative.
3. Reynolds American (NYSE:RAI)
Overview
| 2012 EST. | ||||
| Share price | EPS | Dividend | Yield | Dividend Cover |
| $43 | $3 | $2 | 5.42% | 1.2 |
Cash Flow Statement
| $US MILLIONs | 2010 | 2011 | 9 Months to September 2012 | |
| Net Operating Cash Flow | 1270 | 1420 | 907 | |
| Net Investing Cash Flow | -433 | 60 | -26 | |
| 0 | ||||
| Cash Dividends Paid - Total |
| -1210 | -977 | |
| Repurchase of Common & Preferred Stk. | -5 | -282 | -851 | |
| Issuance of long term debt (Reduction) | (300) | (400) | 0 | |
| Net Financing Cash Flow |
| -1892 | -1598 | |
| Free Cash Flow | 518 | -412 | -717 | |
| Free Cash Flow ex debt buyback | 818 | -12 | -717 |
Once again RAI is only just covering its dividend from EPS. However, it has been buying back debt rather than issuing it. Still, cash flow is coming under pressure.
Philip Morris International (NYSE:PM)
Overview
| 2012 EST. | ||||
| Share price | EPS | Dividend | Yield | Dividend Cover |
| $90 | $5 | $3 | 3.67% | 1.6 |
Cash Flow Statement
| Philip Morris International | |||
| $US MILLIONs | 2010 | 2011 | 9 Months to September 2012 |
| Net Operating Cash Flow | 9440 | 1053 | 7770 |
| Net Investing Cash Flow | -710 | -1030 | -691 |
| 0 | |||
| Cash Dividends Paid - Total | -4420 | -4790 | -3980 |
| Repurchase of Common & Preferred Stk. | -4800 | -5300 | -3210 |
| Issuance of long term debt (Reduction) | 938 | 2060 | 3912 |
| Net Financing Cash Flow | -8580 | -8340 | -4893 |
| Free Cash Flow | 150 | -8317 | 2186 |
| Free Cash Flow ex debt issuance | -788 | -6257 | -1726 |
PM has the best dividend cover in the group. However, the cash flow statement could be better with high debt issues still needed to cover buybacks and dividends. In fact, debt issuance in 2011 was 200% of net operating cash flow.
The result is that dividends for most firms do seem to be covered through free cash flow, however, stock buy backs are usually not covered and money needs to be borrowed to fund them. This causes a problem for big tobacco, as with falling volumes the tobacco companies need to improve their EPS. The easiest way to do this is to buy back shares.
The conclusion - most dividends look safe for now. However, total shareholder returns could come under significant pressure in the future.
