Seeking Alpha
Long only, deep value, growth at reasonable price
Profile| Send Message|
( followers)  

Summary

  • The company has one of the lowest payout ratios in the sector.
  • Average annual growth in dividends of about 12% during the last five years.
  • Future growth opportunity in the hybrid and e-cigarettes segments.

The tobacco industry has some of the highest-yielding stocks in the market, with an industry average of 4.4%. Due to which, the industry has become a paradise for income investors. However, the tobacco industry has always faced criticism due to the health concerns, and there have been calls for a ban on tobacco altogether. It is fair to say that the tobacco industry faces considerable political and social challenges. However, despite these challenges, these companies have been able to distribute a good amount of money to their shareholders.

Philip Morris (NYSE:PM) is a part of this high-yielding industry. PM is a holding company, with its affiliates and subsidiaries engaged in the manufacturing and sale of cigarettes and other tobacco products in markets outside of the U.S. In 2008, Altria Group (NYSE:MO) spun off PM to pursue sales growth in the emerging markets. In this article, I will discuss the reasons for the higher margins, solid cash flows, and diverse geographical revenue base and payout ratio of the company in the tight socio-political situation of the tobacco industry.

Growth in Dividends

Philip Morris has been growing its dividends on a consistent basis, and the company has grown its quarterly dividends at an average annual growth rate of about 12% since 2008. At the moment, the company pays an annual dividend of $3.76 per share, yielding 4.75%. During the last year, PM distributed cash dividends of $5.7 billion. Furthermore, the company repurchased shares worth $5.9 billion, which means the total cash returned to shareholders was $11.6 billion in the last year.

Moving on to the payout ratio - the payout ratio based on the free cash flows is solid for Philip Morris. As mentioned above, the total dividends paid for the last year stood at $5.7 billion, and free cash flows for the same period were $8.9 billion, which puts PM's payout ratio at around 64%. PM's payout ratio is the lower than the other two peers mentioned in this article (shown in the table below).

Dividend Per Share

Average Growth in Five Years

Free Cash Flows

(Billions)

Cash Dividends

(Billions)

Payout Ratio

Philip Morris

$3.58

12%

$8.9

$5.7

64%

Lorillard

$2.2

16%

$1.13

$0.8

71%

Altria Group

$1.92

13%

$4.25

$3.6

85%

Source: Morningstar

It is clear from the table that Philip Morris falls behind its peers when it comes to dividend growth. Lorillard (NYSE:LO) has grown its dividends at a much higher rate than PM and Altria Group has also grown its dividends at a slightly better rate than PM. However, the payout ratio of the company is lower than the other two peers, which gives it more room to grow its future cash dividends. Despite an increase of about 14% in capital expenditures, the company has managed to produce robust free cash flows. However, for the next year, PM has reduced its CapEx guideline, which means the free cash flows will remain robust and the payout will also remain close to the current levels.

Future Growth Prospects

The environment is becoming less favorable for the tobacco industry due to the increasing regulation and consumer health-consciousness. Philip Morris was present at the Consumer Analyst Group of New York (CAGNY) Conference - the company stated that the international cigarette industry volume has declined by 3% over the last year. Moreover, the increased cigarette prices have dragged down the sales of tobacco products in the global markets. European Union, which accounts for 27% of PM's total revenue, suffered from unemployment crises, further decreasing the sales of the company. However, the company was able to maintain and increase its market share to about 35%.

The key growth driver for PM is Marlboro, with new architecture, consumer relevant information, and new marketing campaigns; PM was able to sell over 291 billion units of Marlboro during the last year. As I mentioned at the start of the article, the tobacco industry is facing a lot of troubles due to the increased regulation. Therefore, the companies need to diversify their product lines with the help of technology. PM is also considering introducing reduced-risk products, such as hybrid and e-cigarettes, which can be solid growth drivers for the company. According to company estimates, if the adoption rate of the reduced-risk products is 3%-5%, then the net incremental annual volume could be 30-50 billion units, with potential additional margins of $720 million to $1.2 billion over time.

Conclusion

There is no doubt that the increased awareness has affected the tobacco industry, and the consumer is becoming extremely sensitive. As a result, the future growth prospects of these companies have been questioned. However, despite these issues, Philip Morris has been able to grow its dividends and generate solid free cash flows. I believe the company will continue to grow its dividends and it will be a good addition to a dividend portfolio.

Source: Philip Morris: A Good Dividend Pick?