How Much Should Philip Morris Raise Its Dividend?

Jul. 9.13 | About: Philip Morris (PM)

Each summer, I discuss a bunch of names that will be looking to increase their dividends in the second half of the year. I've already looked at some tech giants, and today I will shift my focus to the cigarette space. It's a name I discuss quite often on this site, and I'm talking about Philip Morris (NYSE:PM). Today, I'll look at the company's dividend history post spin-off and against other names in the space. I'll examine the decreased share count from the buyback, and analyze how the balance sheet is doing in terms of financial flexibility. In the end, I'll examine where I think the dividend goes from here.

Dividend history:

The following chart shows Philip Morris' quarterly dividend rate since the company was spun off in 2008. The dividends below are presented as the years in which they were raised to that value. So for instance, the current $0.85 value is in the 2012 year because it was raised to that $0.85 level in 2012.

*Original dividend was $0.46 per quarter when the company was spun off in 2008. The company paid that rate before the raise to $0.54 later in 2008. So I have put that $0.46 rate at the "2007" level. You can view the company's dividend history here.

Since 2008, the dividend has gone from $0.46 a quarter to $0.85. It could get to $0.92 this year, which would mean that the dividend doubled in six years (counting the $0.46 level as 2007). In four of the five raises, counting 2008 as a "raise" really, the raises have been more than 10%, with two of them more than 17%. The only time that the dividend was not raised by more than 10% was in 2009, at which time it was raised by 7.41%. Obviously, that was due to the financial crisis, and a 7.41% raise is still fairly decent. There were many companies who just maintained, or even cut, their dividends in that time period. Last year's 8 cent raise to $0.85 per quarter represented a 10.39% increase.

Share buyback / reducing the count:

As many investors know, Philip Morris has a huge $18 billion buyback plan underway, expected to last three years. The company expects to repurchase $6 billion worth of shares this year, or $1.5 billion per quarter. The company has significantly reduced the share count in recent years. The table below shows the number of shares used for earnings per share purposes (in millions) over the past few years, at the end of Q1. Now, the outstanding share count will vary slightly, but I'm more concerned with this one as it is the one used to calculate EPS.

Why did I show the table? Well, they reduced the number of Q1 shares by around 4.25% over the past year. This allows an increase in dividend payments without increasing the total dollar payout because there are less shares. So for instance, if you have $1,000 to pay out to 50 shares, each share would receive $20. But if you cut that to 40 shares, and you still pay out $1,000, each share gets $25. The math is a little extreme in that case, but you get the point. Reducing the amount of shares helps increase dividends over the long term.

Balance sheet update:

A company cannot increase its dividend if it does not have the financial flexibility to do so. While I've loved Philip Morris over the past few years, the one criticism I have is that the balance sheet is weakening by the quarter. The following table shows some key balance sheet ratios in past years, with dollar values in millions.

Click to enlarge

Philip Morris has taken advantage of low interest rates to pay sizable dividends and buy back stock. However, the debt load at this company is piling up. At the end of the last two quarters, the company had more liabilities than assets, with a debt (liabilities to assets) ratio that has gone from 85% to 107% in just two years. If this ratio continues to increase, it will have severe consequences down the road. At the moment, I'm not pushing the panic button, as there is still enough financial flexibility to raise the dividend. However, a few years down the road, things might be different.

Comparable dividends:

When it comes to the cigarette names, there are three other companies I currently look at: Lorillard (NYSE:LO), Altria (NYSE:MO), and Reynolds American (NYSE:RAI). Philip Morris has a solid dividend, yielding 3.84% on an annual basis as of Monday's close. That's about 21 basis points more than a 30-Year US Treasury bond. The gap has narrowed, as interest rates have really started to jump. Some might argue that Philip Morris and other high yielding dividend stocks become less attractive when rates rise, but I think that Philip Morris' growth and buyback offset that fact. The chart below shows a comparison of these four names in terms of current dividend yields.

Reynolds American sports the highest yield at 5.03%, but as I've discussed in recent articles, has the lowest expected revenue and earnings per share growth this year. Reynolds has already increased its dividend this year. Altria comes in second with a 4.88% yield, and has not raised its dividend yet. Altria will likely raise its dividend in the next few months. When Altria does, it will have a comparable yield to Reynolds most likely, and one higher than Lorillard. Altria has more expected revenue and earnings growth than Reynolds, but much less than Lorillard and Philip Morris. Lorillard checks in with a 4.82% yield, and they have already raised their dividend this year. Philip Morris trails two of the three by more than a full percentage point in terms of yields right now. However, it is the buyback that really makes Philip Morris attractive.

Raise prediction:

In the following table, I provided some details on what a dividend raise could look like. I provided the new quarterly dividend, the cent per quarter raise it would be, the percentage increase of that raise, and the corresponding annual yield (as of Monday's close). Obviously, the yield number is fluid, and will change depending on how the stock moves before the actual raise. In yellow, I highlighted my prediction for the raise, which I'll discuss below.

I mentioned above that the share count is down a little more than 4% since last year. That gets us to about $0.89 per quarter, but I've gone up a penny more which would be a "real" raise. If a company reduces the share count by 5%, I really don't count a 5% dividend increase as a "raise" because they would be paying out the same amount of money overall. So the minimum raise I could see would be one to $0.90 per quarter, a "raise" of 5.56%. This would get the yield back over 4.00%, assuming the stock is below $90 a share at that point.

Last year's raise was 10.39%, which almost equates to a 10 cent raise this year to $0.95 per quarter. With the balance sheet getting a little bit worse, I don't see a 9 or 10 cent raise, because I don't think the cash flow justifies that large of a raise right now. Philip Morris expects to spend $6 billion on buybacks this year, and I don't want to see this company's debt pile continue to increase at the rate it has been. I think the highest amount should be 8 cents. A dividend raise of 8 cents to $0.93 per quarter would be an 8.60% raise, and would put the yield at 4.20% as of Monday's close. In terms of investors, I would be disappointed with anything less than a five cent raise, and I'd be a little worried financially at anything around 10 cents or more.

Final Thoughts:

We are approximately two months away from the next declared dividend for Philip Morris. The dividend history page I linked to above shows September 11th as the next dividend announcement date, give or take a few days probably. While that would be the day the dividend is declared, it is possible that Philip Morris could announce its annual raise before then. Today, I covered the dividend history of Philip Morris, and looked forward to the raise that we expect rather soon. My prediction is for a raise of 5 to 8 cents, which would put the quarterly dividend at $0.90 or above, and the dividend yield back above 4.00% (as of Monday's closing price). What is your prediction? I look forward to hearing your thoughts below.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.

Additional disclosure: Investors are always reminded that before making any investment, you should do your own proper due diligence on any name directly or indirectly mentioned in this article. Investors should also consider seeking advice from a broker or financial adviser before making any investment decisions. Any material in this article should be considered general information, and not relied on as a formal investment recommendation.