It's always interesting to separate facts from headlines. The main point of a story is often well highlighted in the headline, but the devil is often in the details.
While the S&P 500 and its tracking exchange traded fund, SPY, has rallied nearly 25% since the summer of last year, dividend stocks have been the best performing stocks over the last three years.
No dividend stock has been more popular than Altria (MO).
Altria is the largest tobacco company in the U.S., and the company recently raised its dividend nearly 7% after having reported second quarter earnings of $.60 a share. Management also reiterated its guidance for the full year of $2.17-2.23 after reporting second fiscal quarter earnings.
Altria's recent earnings report and substantive dividend raise certainly appear impressive. Still, while the company's recent earnings were above expectations, there are strong signs that the company's current payout ratio and dividend policy are unsustainable.
Just last month the U.S.'s biggest tobacco company announced that the company would likely take a $.18 per share hit because of plan to repurchase nearly $2 billion in debt, with management recording a pre-tax loss of nearly $1 billion. The company was also forced to lower its previous guidance for this year from $2.17-2.23 to $1.96-2.00 a share. While management recently revised its guidance several weeks ago to $2.01-2.07 a share, the company has still been forced to significantly lower its guidance from last quarter.
What is so interesting to me about Altria's recent dividend raise and the company's debt buyback initiative is that these events show how reckless the company's current dividend policy is.
Altria's recent earnings report showed solid volume gains of over 20%, with the company's discount L&M brand taking market share at the lower end. Still, Altria's flagship brand, Marlboro, continues to ship fewer cigarettes each year, and the company's volumes declined by nearly 2% for the year as well. Altria continues to raise prices to offset declining volumes and increasing taxation levels, but the company's market share losses to competitors Lorillard (LO) and Reynolds (RAI) suggest the U.S.'s biggest tobacco company has limits to its pricing power as well. Lorillard and Reynolds both took significant market share from Altria over the last several years with cheaper cigarettes that were aggressively marketed to blue collar and younger smokers.
Altria bought back $66 million in shares the previous quarter at $32.36, so the company's single digit adjusted earnings growth was impacted by share repurchase. The company's share buyback plan is also financed with debt, and Altria's long-term cost of capital is over 5% as well. While Altria continues to initiate cost savings plans, raise prices, and buy back shares, the company's organic growth is very minimal.
Altria has more than $14 billion in long-term debt, and the company has only 6x coverage of interest rate payments, far less than peer Philip Morris International (PM), which has 13x coverage of interest payments. The company has been able to rely on cheap debt to finance the company's buyback and dividend plan the last couple of years, but the company's long-term cost of capital remains at around 8%. Management has essentially been using a carry trade, where the company's cost of capital has been lower than the dividend, so the company has been borrowing to raise dividend payments and buy back shares even as net income growth has been minimal since 2010. If interest rates rise even minimally, the company will also have significant difficulty raising dividend payouts, and management may have to reduce the payout ratio as well.
To conclude, many companies continue to raise dividend payments at unsustainable levels, but capital will not remain artificially cheap forever. Altria's buyback and dividend policy are boosting the stock today, but if the company needs to increasingly recall the debt used to finance these shareholder returns longer-term, the current dividend policy will severally limit management's flexibility. The U.S.'s biggest tobacco company trades at 15x consensus estimates for next year's likely earnings despite analyst projections for mid-single digit growth over the next several years and Altria has had minimal net earnings growth over the last several years. While many consumer staple companies have been the best performing stocks in the market over the last three years, past results are not always indicative of likely future performance.