Unlike many of its tobacco peers, Philip Morris (NYSE:PM) has not had a good 2014. The stock has been frustrated by constant currency woes, secular volume declines in mature markets, regulation issues in the EU, and some legacy high-cost structures. However, even with these concerns, Philip Morris has historically been a good long-term pick for dividend growth investors. I believe the stock is a buy at current prices, especially as we should see the annual dividend increase announcement coming up soon.
Making sense of the payout ratio
Perhaps one of the most frustrating aspects of analyzing Philip Morris is the issue of its dividend payout ratio. For most companies, this is a simple enough calculation. However, Philip Morris has stated that it looks at its dividend policy via both "currency adjusted" and "normal" EPS growth.
Philip Morris has targeted a 65% payout ratio. This is NOT a firm number, nor does it imply that there is a lack of wiggle room. Indeed, as I noted in a recent article, Philip Morris is committed to rewarding its shareholders first and foremost, regardless of the headwinds it is facing.
With that out of the way, let us look at the current year EPS guidance, both adjusted and non-adjusted:
- Non-adjusted: $4.92 (Midpoint)
- Adjusted: $5.40
As we can see, there is a big difference between the two numbers. Assuming Philip Morris held firm to its 65% payout ratio, these would be limits to the dividend:
- Non-adjusted: $3.20
- Adjusted: $3.51
Given that the current dividend is $3.76 per share ($0.94 per quarter), Philip Morris is already above its target 65% payout ratio for both metrics (76% and 69%).
This begs the question: Does Philip Morris have room for a dividend increase? The answer to this question is an obvious yes. Nothing serious will happen if the company sees a short-term uptick in the payout ratio for one year. This would the exception, not the rule.
How much of an increase can we expect?
In an earlier article, I estimated that Philip Morris may only offer a modest 1% to 5% dividend increase for 2014. However, I think this range should be higher after going over the Q2 conference call.
The company noted once or twice that its adjusted EPS growth would be in the 6% to 8% range. This range, in my opinion, a good yardstick for the next dividend increase.
My rationale for this is rather simple. Philip Morris tends to measure its success on the adjusted numbers, including, I believe, performance metrics for senior management. It stands to reason that this same logic may apply when it comes to the dividend policy.
As a result, I am upping the high end of my increase estimate to 6%. The new range is now 1% to 6%, or $3.80 to $4.00 annually ($0.95 to $1.00 per quarter). Do note the 1% increase is the worst case scenario and is much less likely than the others.
The payout ratio for this new dividend would be from 70% to 74% using 2014 adjusted EPS and from 77% to 81% using non-adjusted EPS.
At current prices, this would have Philip Morris yielding 4.44% to 4.67%, above peer Lorillard (NYSE:LO) at 4.12%, inline with Reynolds American (NYSE:RAI) at 4.58%, but below sister stock Altria (NYSE:MO) at 4.83%.
Even with the dividend increase, 2014 stands to be the worst year for Philip Morris since its 2008 spin-off from Altria. However, the company may surprise us long-suffering shareholders with a robust dividend hike. I suspect the stock to get a boost once the announcement is made, usually around early September.
Disclaimer: The opinions in this article are for informational purposes only and should not be construed as a recommendation to buy or sell the stocks mentioned. Please do your own due diligence before making any investment decision.
Disclosure: The author is long PM, MO.
The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.