A recent Seeking Alpha article argues that Philip Morris' (NYSE:PM) dividend is reaching a level the company cannot sustain. The article also suggests Altria Group (NYSE:MO) as the better alternative to hold. We own both Altria and Philip Morris with satisfactory results so far.
But, is Altria's free cash flow [FCF] really better than PM's? Let's find out, using trailing twelve months [TTM] and five year FCF numbers.
Philip Morris:
- Total shares outstanding: 1.549 billion
- Current quarterly dividend per share: $1.02
- Quarterly FCF required to cover dividends: $1.57 billion
- Average FCF over the last 5 years: $1.633 billion
- Payout using 5 year FCF: 96% ($1.57 billion divided by $1.633 billion)
- Average FCF over TTM: $1.72 billion
- Payout using TTM FCF: 91% ($1.57 billion divided by $1.72 billion)
Altria:
- Total shares outstanding: 1.958 billion
- Current quarterly dividend per share: $0.565
- Quarterly FCF required to cover dividends: $1.10 billion
- Average FCF over the last 5 years: $1.07 billion
- Payout using 5 year FCF: 102% ($1.10 billion divided by $1.07 billion)
- Average FCF over TTM: $1.35 billion
- Payout using TTM FCF: 81% ($1.10 billion divided by $1.35 billion)
Source: Ycharts.com
So, PM has a better coverage using the five year average while Altria has the better coverage using TTM numbers. But neither company outweighs the other significantly. If anything, going by the text-book approach, investors will usually be advised to stay away from BOTH stocks. Not just Philip Morris.
But, Altria remains our #1 position and PM is #4 in a portfolio consisting of 12 stocks. Why so, if the numbers above look dangerous for both the stocks?
- Pedigree: When it comes to investing, it's advisable to look forward and not much at the past. But there are special cases where this doesn't hold as much merit. Just like how rules and records are meant to be broken. We are not saying that Altria's and PM's future isn't important. But the fact that these companies have operated for decades while continuously delivering to shareholders needs to be taken into account. And yes, PM as a stand-alone company has been around for less than 10 years. But being an Altria spin-off, PM knows how to reward shareholders as well.
- Experience: Altria (when it was Philip Morris) has been through much more challenging situations than exchange rates fluctuations. The company never reduced its payout to shareholders and in fact increased it every single year one. PM definitely has the same genes.
- Future: Perhaps the recent share price movement is a sign of things to come? Make no mistake about it, the market is more forward thinking than most individual investors. Prices quickly adjust to available information except for some thinly traded securities. While we aren't big fans of analyst upgrades after a stock has risen, a recent upgrade does suggest that things are looking up.
- Evolution: This company (or these two companies) knows how to evolve and not be left behind. After venturing into E-Cigarettes, PM is now trying out "Heat-Sticks" which heat rather than burn tobacco. While most people know there is nothing "safe" about tobacco, companies are always on the lookout for the "safest". PM has taken the lead once more.
- Reality: So what if PM's stock has risen recently? The stock still yields 4.20%, double the market average. With the Federal Reserve's back and forth on interest rate, income stocks will continue attracting investors. For some, it's all about their income and cash flow.
Conclusion: We aren't arguing that PM is a bargain here and this is the moment to backup the truck. On the same vein, this isn't the time to sell either (perhaps never is). If you have many safe alternatives that will beat a 4% yield that will almost certainly keep growing each year, by all means go ahead. But chances are that most investors wouldn't find too many alternatives. That's precisely why leaders like Altria and PM some time appear a little overvalued.
Lastly, SA readers are perhaps sick of reading about Warren Buffett but here is something to chew on. Buffett, the younger version, relied only on Ben Graham's margin of safety [quantitative] with admittedly mixed results. Buffett, the man as we know him today, used Charlie Munger's qualitative approach to acquire stocks like Coca-Cola (KO) and Gillette [later acquired by Procter and Gamble (PG)].
