Philip Morris: What To Expect For The Dividend

| About: Philip Morris (PM)


PM raised its dividend only 2% last year, while it had raised it at a compounded annual rate of 11.7% in the previous 7 years.

A similar dividend increase should be expected this year unless the dollar pronouncedly weakens in the rest of the year. In that case, a 5%-7% raise is more likely.

The extremely high payout ratio, the weak balance sheet and the lack of earnings growth do not leave much margin for a much higher raise of the dividend.

It is well known that most of the shareholders of Philip Morris (NYSE:PM) hold the stock mainly for its high and growing dividend. That's why there is always a lot of discussion on the expected growth rate of the dividend. As the company is expected to raise its dividend in the end of September, just like every year, I will analyze what dividend growth rate the shareholders should expect for this year.

First of all, the payout ratio is pronouncedly high, as it currently stands at 92%. This high payout ratio has simply resulted from the lack of earnings growth in the last 7 years. More specifically, the earnings of the company in 2015 were essentially equal to those of 2008. Of course thanks to the aggressive share repurchases of the recent years, the earnings per share [EPS] have increased since 2008 but still they have decreased 9% in the last 4 years. A major reason for the decrease is the strong dollar but, even if the currency headwind is adjusted, the EPS have increased only 16% in the last 4 years, solely thanks to the share repurchases. Therefore, the remarkably high payout ratio and the inability to grow the earnings do not bode well for the future dividend increases, at least on the surface. That's why the company raised its dividend only 2% last year, while it had raised it at a compounded annual rate of 11.7% in the previous 7 years.

In the recent years, Philip Morris executed aggressive share repurchases, which somewhat mitigated the financial burden of the dividend on the company. More specifically, from 2008 to 2014, the share count was reduced by 25%. While the dividend doubled during that period, the meaningful decrease of the outstanding shares partly offset the financial burden on the company. However, the company eliminated its share repurchases last year and is not likely to resume them at a meaningful rate this year.

To be sure, the aggressive distributions to the shareholders pronouncedly weakened the balance sheet in the last few years. More specifically, the book value decreased from $7.9 B in 2008 to -$13.2 B in 2015. In addition, the net debt (as per Buffett, net debt = total liabilities - cash - receivables) pronouncedly increased in the last 4 years, from $29.5 B to $41.0 B. This resulted in an increase in the annual interest expense, from $0.93 B in 2011 to $1.13 B last year. To make a long story short, the positive effect of a reduced share count on the EPS has started to be offset by a higher interest expense. Therefore, there is minimal or no benefit from adding new debt to fund share repurchases. All in all, the shareholders should not expect meaningful share repurchases this year and hence the burden of the dividend increase on the balance sheet will be fully felt this year. Of course the management may decide to keep adding new debt to resume share repurchases but that will not be a sound strategy for the long-term shareholders.

Fortunately for the shareholders, there is a wild card for the company. More specifically, while the earnings have been severely beaten by a strong dollar, the market has recently started to realize that the hikes of interest rates by Fed will be much slower than initially expected. This has somewhat softened the dollar and, even better for Philip Morris, the dollar is likely to continue to weaken in the near future, at least in my opinion. Consequently, the company may realize significantly higher earnings this year and next year than the current estimates. In such a case, the management may decide to raise the dividend by up to 5%-7%. I do not believe that the raise will be greater because every dividend raise essentially poses a long-term commitment to the management, as the latter will want to avoid a future dividend cut by any means. All in all, if the dollar weakens during the rest of the year, the management may raise the dividend by up to 5%-7%. If the dollar remains strong, the dividend hike is likely to be similar to that of last year, i.e., 2%. The shareholders should not count on a higher raise this year.

As a side note, Philip Morris has greatly outperformed the market in the last 12 months. To be sure, while S&P (NYSEARCA:SPY) has remained essentially flat during that period, Philip Morris has rallied 30%. This vast outperformance has been observed in most tobacco stocks. While this is a favorable trend for the shareholders, it should be noted that the rally of the stock has not resulted from EPS growth; instead it has resulted from the expansion of the P/E ratio, with the stock now trading at a forward P/E=22.4. Therefore, while the stock has great momentum and is likely to maintain it in the short term, investors who are on the sidelines are not likely to enjoy great long-term returns from the current levels.

To sum up, Philip Morris raised its dividend at the lowest rate ever last year and is likely to raise it at a similar rate in September. If the dollar eventually weakens due to a slower pace of interest rate hikes, it will provide the company with a tailwind and hence the dividend raise may be up to 5%-7% this year. However, if the company does not return to meaningful organic growth in the near future, its shareholders should not expect higher raises in the next few years. The pronouncedly high current payout ratio and the leveraged balance sheet should force the management to return to meaningful organic growth and not just focus on extreme distributions (greater than the earnings) to the shareholders.

Disclosure: I/we 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.

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