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Edited by Adam Isaac

Philip Morris (NYSE:PM) is one of the biggest cigarette brands in the world. The company has seven brands in the top fifteen brands of cigarettes in the world, including Marlboro, the number one cigarette brand worldwide. Philip Morris offers impressive dividend yield and juicy dividends. The company has been increasing dividends consistently. After the recent increase, the quarterly dividends for the company stand at $0.85. In my previous articles, I have talked about the valuation, earnings and the dividend stability of the company. However, it is very important to analyze a company's cash flows, payout ratio and coverage metrics to establish if the company will be able to maintain its dividends. I look at these factors one by one in this article.

Payout Ratio:

It is one of the most critical metrics for gauging dividend sustainability. An unnaturally high ratio indicates that the company may be making payouts it can't afford. It is likely that too high payout ratio will be brought down in the future, which can cause dividends to go down. However, Philip Morris has a manageable payout ratio of 55%, which the firm should be able to maintain.

Free Cash Flows:

 

Free Cash Flows

 
 

2011

2010

2009

Net Income

$8,591

$7,259

$6,342

Depreciation and other noncash charges

$993

$932

$853

Funds from Operations (FFO)

$9,584

$8,191

$7,195

change in noncash current assets

$287

$1,194

$473

change in noncash current liabilities

$199

$72

$116

Operating Cash flows

$10,070

$6,925

$6,606

Capital Expenditures

$897

$713

$715

Free Operating Cash Flow

$9,173

$6,212

$5,891

    

Long Term Debt

$14,828

$13,370

$13,672

Source: SEC filings

Over the past three years, the company has shown impressive increase in its funds from operations. At the end of 2009, FFO for Philip Morris stood at just above $7 billion. However, by the end of 2011, FFO for Philip Morris had jumped up to over $9.5 billion. Along with FFO, operating cash flows for the firm have shown a steady upward trend. At the end of 2011, operating cash flows stood at just above $10 billion up from $6.6 billion at the end of 2009. An increase in operating cash flows indicates that the firm is managing its operations efficiently. In addition, the firm has been investing a considerable amount of money in capital expenditures.

Philip Morris spent almost $900 million in capital expenditures at the end of 2011. Moreover, free operating cash flows have increased incredibly during the past three years. Free operating cash flows have seen an increase of almost $3 billion in the previous three years. However, the firm has relatively stable debt levels. The long term debt for Philip Morris has between $13.5 billion and $15 billion. At the end of 2011, the long term debt stood at $14.8 billion.

Essential Ratios:

 

Essential Ratios

 
 

2011

2010

2009

Funds from Operations(FFO)/Total Debt

0.65

0.61

0.53

FFO/Capital spending requirements

10.68

11.49

10.06

Free Operating Cash Flow + interest expense/ Interest expense

12.47

8.09

8.39

Debt Service coverage

3.32

3.13

7.84

The first ratio (FFO/Total Debt) shows an improvement for Philip Morris. FFO to total debt ratio is a conventional ratio to measure a company's ability to meet its debt obligations. As it is clear from the table, the firm is in a strong position, and FFO to total debt ratio is improving for Philip Morris. FFO to capital spending requirements ratio is extremely healthy for Philip Morris and currently stands at above ten. It is especially important for dividend paying companies to have healthy coverage ratios. If the firm is not able to meet its debt obligations, it is likely that the firm will cut its dividends to meet its debt obligations.

However, Philip Morris seems to be able to handle the situation as it has incredibly strong coverage ratios. The interest expense for Philip Morris is low and has not touched $1 billion in the previous three years. As a result, the interest coverage ratio is extremely strong at 12.47. In addition, Philip Morris has been able to meet its debt service requirements, and a ratio of 3.32 indicates a strong position for the tobacco company. After the analysis, we can say that the firm should not have any trouble meeting its debt obligations and the dividends of the company look safe.

Summary:

The best dividend paying companies have the financial strength to fund growth and sustain any economic slowdown or a temporary crisis. As a result of my analysis, I can say that the firm is in an extremely comfortable position. Philip Morris has impressive metrics, which back the recent increase in its quarterly dividends. At the moment, I believe Philip Morris is an extremely attractive stock to add to the dividend portfolio. Healthy growth for Philip Morris in Asian markets should further augment the position of the company and give it an opportunity to grow.

Source: Philip Morris: Impressive Cash Flows Support Healthy Dividends