11 Incredible Dividend Stocks: Philip Morris International

This article is part of our weeklong series on 11 incredible dividend stocks. You can get the low-down on this series by clicking here.

History has some simple lessons about companies with the greatest long-term returns. They produce simple products that aren't subject to fads and rarely change over time. They're hated by much of the investment community. They have name-brand products and loyal customers. Their mission above all else is to produce shareholder returns.

It's for these reasons and more that I'm picking Philip Morris International as one of The Motley Fool's 11 incredible dividend stocks.

The business
Philip Morris International (PMI) is the international division of Philip Morris. The U.S. arm is still held by Altria Group (NYSE: MO  ) , which spun off Philip Morris International in 2008. Its largest and most popular brand, Marlboro, is the world's best-selling cigarette. Excluding China, PMI holds a 27% market share in the international cigarette market, and reaches nearly every inch of the globe. By operating income, 38% of PMI's business comes from the European Union; 28% Eastern Europe, Middle East, and Africa; 27% Asia; and 8% Latin America and Canada.

Here are its basic stats:

Company Philip Morris International (NYSE: PM  )
Dividend Yield 3.7%
Dividend Growth Rate 9.6% annually since becoming independent in 2008
Payout Ratio 61%

Source: Capital IQ, a division of Standard & Poor's.

Why it's incredible
What makes PMI incredible is really what makes the tobacco market in general incredible: pricing power. It's the ability to raise prices not only with inflation, but ahead of inflation, ahead of tax hikes, regulatory burdens, and, when applicable, at a faster rate than cigarette volumes are falling.

Since PMI just recently became independent, it makes sense to look at the long-term history of its former parent, Altria, to see the long-term beauty of this pricing power. Smoking rates in the U.S. have been declining for decades, while Altria shares have produced astounding double-digit returns for shareholders. In 2000, adult smoking prevalence in the U.S was approximately 23%. By 2009, it had fallen to around 18%. Bad news? Hardly. Altria's net income from U.S. tobacco increased steadily during the period.

PMI is in a similar boat. International cigarette growth is meager, if not declining. Yet price increases have kept earnings not only afloat, but driving higher. "Pricing will ... remain the key driver of profitability growth at PMI" said Chief Financial Officer Hermann Waldemer in a recent shareholder conference call. PMI's annual report gives another anecdote: In 2010, price increases "outpaced unfavorable volume ... by a factor of more than two."

That's a wonderful thing. So much of a company's fate is outside management's hands. Management can't do anything about demographic growth. Health trends, taxes, social preferences, and labor costs sit outside their power. Companies with pricing power have a leg up on those uncertainties. Earnings become less dictated by customer demand. Rather, customer prices become dictated by management, and shareholder returns remain relatively steady in all kinds of economic environments. This advantage helped make Altria the best-performing stock over a half-century period ending in 2003.

Another strength of PMI and the tobacco industry: It rarely changes. Tobacco. Paper. Package. That's what cigarettes looked like 100 years ago, and it's what they'll look like 100 years from now. The monotony of the industry keeps capital expenditures low. There's no need to invest in expensive innovation like, say, the technology industry, which undergoes a complete transformation every few years. Less cash for investments, more cash for shareholders. These commodity-type businesses are typically overrun with competition, but advertising restrictions and brand loyalty make breaking into the tobacco industry exceedingly difficult.

Dividend strengths
Tobacco is, of course, a sin industry. A lot of people hate it. Can you blame them? It does social harm. It's terrible for you. It smells bad. It turns your lungs black and your teeth yellow.

Yet somewhat counterintuitively, this rightful loathing is a boon for shareholders. Having a large chunk of the investment community refusing to touch stocks like PMI keeps valuations relatively low. It's like a permanent antidote against euphoria. Quite simply, lower valuations equal higher dividend yields. As a result, PMI is one of the few companies that can duly be considered both a growth stock and a high-yielding dividend machine.

Risks
There are no sure things in investing, and PMI is no exception. The tobacco industry is invariably ensnared in legal woe. If former customers aren't suing the industry, government bodies are. Past legal hurdles have been surmountable, but those could become famous last words. (This legal fog is, however, part of what keeps many investors at bay -- a benefit described above). Another risk is smoking taking on a new degree of social aversion, eventually causing volume to fall faster than pricing power can counteract. I think the odds are firmly in investors' favor, but these risks can't be ignored. PMI should be only part of a diverse investment portfolio.

In sum
Add it all up. PMI shareholders capitalize on global growth, brand-name recognition, pricing power, and a rare loathing from much of the investment community that keeps valuations low and dividend yields high. This stock isn't for everyone. Those who choose to pass for moral reasons can't be blamed. However, for those who choose to make it a part of their portfolio, the rewards can be great.

Fool contributor Morgan Housel owns shares of Philip Morris International and Altria. Follow him on Twitter @TMFHousel. The Motley Fool owns shares of Altria Group and Philip Morris International. Motley Fool newsletter services have recommended buying shares of Philip Morris International. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


Read/Post Comments (5) | Recommend This Article (24)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On June 07, 2011, at 5:17 PM, Fool wrote:

    Morgan -

    Thanks for writing this article.

    Could you comment on what convinced you to give the nod to PMI over Altria? It is due to faster declines in smoking in the US that internationally, or another reason?

  • Report this Comment On June 07, 2011, at 5:35 PM, TheDumbMoney wrote:

    "Having a large chunk of the investment community refusing to touch stocks like PMI keeps valuations relatively low. It's like a permanent antidote against euphoria."

    Great quote.

  • Report this Comment On June 08, 2011, at 4:38 AM, mm5525 wrote:

    Re: Comment #1, I obviously didn't write this article, but as a PM long as my #1 holding by far, I feel moderately qualified to give my two cents.

    Altria (MO) being controlled by the FDA was the deal-killer for me; the lawsuit-happy American public who want to blame cigarette companies for actions they, themselves take; the courts who want big tobacco to pay because of this social stigma. All sorts of attacks on cigarettes in the USA, proposed menthol bans (Big tobacco has been spared this for now), no smoking bans in public places, higher taxes, etc. This is why PM spun out of MO in the first place. Big MO still has their 29% stake in SABMiller, world's 2nd largest brewer, so they get a small bit of international exposure through them.

    PM: All earnings are spread out among dozens of currencies and then converted into US dollars, which is obviously very weak and likely to get even weaker with forever-low interest rates in the USA and massive debt. More people in India, Indonesia, Europe, Africa, South America, Japan, joing venture with the China-government-owned tobacco company, Russia etc than in the USA, and there's just a ton more growth, less regulation, better brands (PM has all sorts of menthol brands like "Ice Blast" "Black Freeze" "Silver Mint" "Gold Touch" etc and others that you can't buy in the USA. More people = More smokers. Don't forget PM has more than just the best-selling brand Marboro. They have L&M, Parliment, Virginia Slims, Chesterfield, and those brands have more flavors unlike in the USA, but MO has those brands in the US as well. Less regulations for PM to deal with, far more growth, younger people, new wealth in Asia with a growing middle class buying things like cars for the first time, etc. These are the reasons why I sold all my MO and put it into PM a few years ago.

  • Report this Comment On June 08, 2011, at 8:33 AM, TheDumbMoney wrote:

    mm525, though, as I pointed out to you on another post, PM hedges out the vast majority of its currency exposure. It is not interested in being a dollar arbitrage operation, it's a cigarette company.

  • Report this Comment On June 08, 2011, at 10:34 AM, mm5525 wrote:

    But the currency differential alone, as well as the ability to hedge, does help PM. From their last earnings press release on April 21, 2011 on Page 2:

    2011 Full-Year Forecast

    PMI increases its 2011 full-year reported diluted earnings per share forecast by $0.20 to a range of $4.55 to $4.65, at prevailing exchange rates, versus $3.92 in 2010. Approximately $0.10 of the increased guidance are attributable to an improved business outlook and approximately $0.10 reflect favorable currency at prevailing rates. Excluding a total favorable currency impact of approximately $0.20 for the full year 2011, reported diluted earnings per share are projected to increase by approximately 11% to 13.5%, or

    by approximately 12.5% to 15% versus adjusted diluted earnings per share of $3.87 in 2010.

    Entire press release:

    http://phx.corporate-ir.net/External.File?item=UGFyZW50SUQ9O...

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