Philip Morris Is A No-Brainer

Jun.15.12 | About: Philip Morris (PM)

Philip Morris International (NYSE:PM) is a dominant international tobacco company, selling products in 180 countries. Its brands include Marlboro, which accounted for a third of total volume in 2011, as well as Chesterfield, Parliament, and Lark. Philip Morris holds a 15.6% market share outside the United States. PM spun off from Altria (NYSE:MO) in 2008 and only operates outside of the United States.

PM ChartClick to enlarge

PM data by YCharts

Philip Morris stock currently trades at $85.71 with a hearty 3.62% yield. Here's the dividend history:

Year Dividend Growth
2008 $1.54* N/A
2009 $2.24 45.45%
2010 $2.44 8.93%
2011 $2.82 15.57%
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*Dividend only paid for three quarters

Since PM spun off in 2008 there is only four years of dividend history, but the growth of the dividend has been exceptional. I'll calculate payout ratio as a percentage of the free cash flow, which is presented below.

Year Free Cash Flow (Mil $) Float (Mil Shares) Payout Ratio
2008 $7,935 2,078 40.33%
2009 $7,884 1,950 55.40%
2010 $9,437 1,842 47.63%
2011 $10,529 1,762 47.19%
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The payout ratio is around 47%, which is fairly low and perfectly sustainable. Philip Morris's dividend appears to be safe.

Valuation

I will use the Dividend Discount Model to put an estimated value on the company. This model assumes that the value of a company is purely the sum of all future dividends discounted back today. This is a reasonable valuation method if you are a dividend investor. The discount rate should be your required rate of return, and I will use a discount rate of 8%, which is roughly the long-term growth rate of the market as a whole. I will assume that the dividend will grow by 8% next year, and then let that growth rate decay over 20 years to a perpetual growth rate of 3%, as per the growth table below.

Year Dividend Growth Rate
2012 8%
2013 7.75%
2014 7.5%
2015 7.25%
2016 7%
2017 6.75%
2018 6.5%
2019 6.25%
2020 6%
2021 5.75%
2022 5.5%
2023 5.25%
2024 5%
2025 4.75%
2026 4.5%
2027 4.25%
2028 4%
2029 3.75%
2030 3.5%
2031 3.25%
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Using these parameters I arrive at a fair value estimate of $85.90 for a share of Philip Morris. This is very close to the current market price of $85.71.

Conclusion

Philip Morris International offers both a high yield and a high dividend growth rate. It operates well known brands and has a significant market share outside of the United States. For a dividend investor, Philip Morris International seems like a no-brainer. Free cash flow has increased nearly 33% since 2008, and the dividend should be able to grow unabated into the future. Also, Philip Morris recently announced a massive stock buyback plan over the next three years, which at these prices is a great idea. Philip Morris offers a fair price, high yield, and high growth, making it a superb addition to a dividend-focused portfolio.

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