Today I would like to take a look at the dividends of four tobacco stocks. This article will help to assess whether or not the companies can maintain the yield that they have and furthermore, whether or not they will be able to increase the dividend in the future. When looking at the companies' dividends, I believe free cash flow is a good indication of their ability to pay the dividend as it shows how much free cash the companies have to be able to pay out dividends to shareholders.
First, let's take a look at Reynolds American's (NYSE:RAI) dividend. Currently, the yearly dividend payout based on the quarterly rate is $2.36 per share and the full year analyst consensus earnings estimate for 2012 is $2.95 (the first three quarters' results are already in). Based on that, the dividend payout ratio is 80%. Looking at the cash flow statement, for the year ended December 31, 2011, cash flows from operating activities less capital expenditures (free cash flow) were $1,313,000,000. Dividends paid out were $991,000,000. There was $1,956,000,000 of cash on the balance sheet at December 31, 2011. For 2011, the dividend payout was well covered.
At September 29, 2012, there was $1,243,000,000 on the balance sheet for cash. For the first three quarters of 2012, per the cash flow statements, free cash flow was $913,000,000 and $977,000,000 was paid out in dividends. It also bought back $851,000,000 of stock in these three quarters. Buybacks reduce the number of shares outstanding, and decrease the amount of cash the company has to pay out in total for dividends. Based on the first three quarters of 2012, its cash was reduced by $64,000,000 by paying the dividend from free cash flow. It has $1,243,000,000 of cash on the balance sheet though as of 9/29/12. That is only 5.1% of the cash on its balance sheet (the $64,000,000 is). Analyst estimates for 2013 earnings are for EPS of $3.12. I think the dividend is in good shape. It can borrow money at very low rates if it needs to for paying off liabilities or for capital expenditures. Based on this, assuming it will earn $3.12 per share in earnings in 2013, by keeping the same 80% payout ratio it could raise the dividend to $2.50 per share. That would be a 5.9% increase.
The next tobacco stock for this analysis is Altria Group (NYSE:MO). It currently pays a dividend of $1.76 per year. The 2012 full year consensus earnings estimate for Altria calls for earnings of $2.21 per share. That is a dividend payout rate of 79.6%, which is very close to the current payout rate of Reynolds. By looking at the cash flow statement for the year ended December 31, 2011, free cash flow (as defined above) was $3,508,000,000. The amount paid out in dividends in 2011 was $3,222,000,000. There was $3,270,000,000 in cash on the balance sheet as of December 31, 2011. Based on this, in 2011 the dividend was well covered.
As of September 29, 2012, there was $2,186,000,000 of cash on the balance sheet for Altria. For the first three quarters of 2012, based on the cash flow statements, there was $2,043,000,000 of free cash flow. $2,508,000,000 was paid out in dividends for those three quarters. It also bought back stock in this period, which shows up in the dividend payout amount for each quarter as the amounts decrease in each quarter. For those three quarters, Altria's cash was reduced by $465,000,000 based on paying the dividends out from free cash flow. $465,000,000 is 21.27% of the $2,186,000,000 in cash on Altria's balance sheet currently. This percentage is higher than that of Reynolds. Analysts estimate, based on the consensus, that Altria will earn $2.38 per share in 2013. If it keeps the same 79.6% payout ratio, the dividend would increase to $1.89 per share. This would be a 7.39% increase from the current amount (which shows a higher potential dividend increase than Reynolds did using this same analysis).
Next, let's take a look at Lorillard (NYSE:LO). It currently pays a dividend of $6.20 per share and has a current yield of 5.20%. The consensus analyst estimate for 2012 earnings calls for earnings per share of $8.38. That is a dividend payout ratio of 73.99%. Based on the cash flow statement for the year ended December 31, 2011, free cash flow was $1,127,000,000. The dividends paid out in 2011 were $723,000,000. There was $1,634,000,000 on the balance sheet for Lorillard as of December 31, 2011. This dividend payout was well covered in 2011 as Lorillard had plenty of cash left after over from free cash flow even after paying the dividends.
For Lorillard, there was $1,715,000,000 of cash on the balance sheet at September 29, 2012. Based on the cash flow statements for the first three quarters of 2012, free cash flow was $590,000,000. Dividends paid out for these three quarters totaled $608,000,000. This was a payout in excess of free cash flow of $18,000,000. That is only 1% of its cash as of September 29, 2012. The analyst consensus EPS estimate for Lorillard in 2013 calls for earnings of $9.10. If it pays out 73.99% of that, the dividend would increase to $6.73 per year. That would be an 8.5% increase from current levels.
For the fourth stock, I would like to take a look at Philip Morris International (NYSE:PM). It currently pays a yearly dividend of $3.40, giving it a yield of 3.90%. The 2012 analyst consensus earnings estimate for Philip Morris International is $5.21 per share. That gives us a dividend payout ratio of 65.2%. The cash flow statement as of December 31, 2011 tells us that free cash flow was $9,362,000,000. The dividends paid out in that time totaled $4,788,000,000. There was $2,550,000,000 of cash on the balance sheet as of December 31, 2011. This dividend payout was clearly sustainable.
Philip Morris International had $4,817,000,000 of cash on the balance sheet as of September 29, 2012. The cash flow statements for the first three quarters of 2012 show us that free cash flow was $7,052,000,000. The dividends paid out were $3,973,000,000 for those three quarters. This dividend looks to be well covered. The analyst consensus earnings estimate for 2013 calls for earnings of $5.81 per share. If it keeps a 65.2% dividend payout ratio, that would give us a dividend of $3.79 per share. That would be an 11.47% dividend increase. I argue that it could even raise the dividend payout ratio if it wanted to, based on its financial position being as strong as these numbers show us.
Conclusion - I think, based on this analysis, that all of these four tobacco stocks have the ability to continue their current dividend payout rates. I also argue that the dividend increases we have seen in the past few years will be continued, assuming earnings come in as estimated. The company out of these four that I think has the highest ability to raise the dividend significantly is Philip Morris International. Based on the current dividend yields of these four companies, Reynolds American has the highest current dividend yield. Going forward though, I estimate that the next annual percentage increases in dividends will show that Philip Morris International will have the highest percentage increase, followed by Lorillard, then by Altria, and finally by Reynolds. I expect them all to increase their dividends. Even after these potential dividend increases for next year, I expect Reynolds American to have the highest yield if the stock prices remain where they are currently. That is, unless Lorillard surprises us with a larger than expected dividend increase which is possible.
Disclosure: I am long MO, PM, LO, RAI. I also have covered calls against some of my positions in MO and RAI. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.