How Sustainable Are Big Tobacco's Dividend Payouts?

Philip Morris, Altria, Reynolds American, and Lorillard are well known for their impressive dividend yields, but how much longer can the payouts continue?

May 15, 2014 at 5:02PM

Tobacco companies like Philip Morris (NYSE:PM), Altria (NYSE:MO), Reynolds American (NYSE:RAI), and Lorillard (NYSE:LO) are well known for their defensive nature and impressive dividend yields. However, declining cigarette sales also haunt these companies, which is of concern to investors as falling sales mean falling profits, and ultimately this could put pressure on their dividend payouts.

Still, tobacco companies are extremely well-run and their dividend payouts are not going to come under any pressure in the near future; here's why.

Crunching numbers
Philip Morris currently offers a dividend yield of 4.7%, more than double the market average and an attractive rate for many investors. Management has been extremely prudent in ensuring the long-term sustainability of the company's dividend.

In particular, after Philip Morris spun off from what is now Altria during 2008, in its first full year of independence the company generated free cash flow of $6.8 billion, from which it paid out $5.1 billion in dividends to investors.

Now, Philip Morris could have paid out a lot more than this in theory, but the company's management team remained cautious. Since then the company's payout has edged up, rising from an initial quarterly payout of $0.46 per share during 2008 to a quarterly payout of $0.94 per share as of the third quarter of this year -- that's growth of 104%.

However, while Philip Morris' quarterly dividend payout has more than doubled, the payout has only grown in-line with funds generated from operations.

In particular, although Philip Morris' payout has risen more than 100% on a per-share basis during the past five years, the company's payout ratio has, for the most part, remained below 60% of free cash flow.

So investors can buy into Philip Morris for the dividend payout, safe in the knowledge that the dividend is well-covered by free cash flow with plenty of room for future growth.

Unfortunately, Altria's dividend is under much more pressure than that of its larger, international peer.

Back in the U.S.
Unlike Philip Morris, domestic U.S. tobacco companies are paying out a higher percentage of their free cash flow in dividends, which looks worrying.

Specifically, during the last five years, Altria has paid out a total of $16.7 billion in dividends. Over the same period, the company has only generated free cash flow of $17.7 billion, which gives a payout ratio of close to 94%.

Nevertheless, Altria has increased its payout 47 times during the last 44 years and this gives me confidence in the company's future payouts, although there is still some risk that the company could be forced to scale back its payouts.

Elsewhere, the dividend payouts of both Reynolds and Lorillard also consume the majority of their free cash flows, although overall the payouts look to be well-covered and sustainable.

 

Lorillard

Reynolds American

5-yr free cash flow

$5 billion

$7 billion

5-yr cumulative dividends paid

$4 billion

$6 billion

Payout ratio

80%

86%

5-yr free cash flow growth

20%

53%

5-yr dividend growth

30%

35%

Source: Marketwatch.com. Figures in $US billions. Rounded to the nearest billion.

It would appear that just like those of Philip Morris, the cumulative dividend payouts of Lorillard and Reynolds American have only risen in line with their cash generated from operations.

How can these payouts continue to rise?
A valid question that investors should be asking is how sustainable are the cash flows of these companies, as the number of smokers around the world continues to slide.

Indeed, a falling number of smokers means lower cigarette sales and ultimately smaller cash flows, which will put pressure on these companies' dividend payouts. Fortunately, big tobacco has thought ahead and is not worried about this issue.

Offsetting falling sales
Big tobacco companies are dealing with falling tobacco sales by increasing prices to offset declining volumes. For example, Altria's most recent price hike came into effect on Dec. 1 as the company added $0.07 per pack to the price of Marlboro cigarettes. This followed a similar $0.06 increase in June.

We can factor this increase into Altria's results to see how it helps keep the company's profits rising.

Specifically, during 2013 the volume of Marlboro cigarettes sold by Altria declined by 4%. However, price increases across the company's tobacco portfolio and lower costs helped Altria's adjusted operating income from smokeable products rise 2.4% during the year.

It's not just Altria that is undertaking this strategy--Reynolds and Lorillard instigated similar price increases throughout 2013. Philip Morris' revenue ticked higher by 3.4% during 2013 while the volume of cigarettes shipped by the company slid 5.1%; this indicates that the company hiked prices.

Foolish summary
Big tobacco companies are known for their impressive dividend payouts, but with the number of smokers around the world on the decline, investors are right to be worried about the sustainability of these payouts.

However, it would appear that tobacco is offsetting falling volumes of tobacco shipped by hiking prices, and for the time being this is safeguarding big tobacco's dividend payouts. 

Top dividend stocks for the next decade
The smartest investors know that dividend stocks simply crush their non-dividend paying counterparts over the long term. That's beyond dispute. They also know that a well-constructed dividend portfolio creates wealth steadily, while still allowing you to sleep like a baby. Knowing how valuable such a portfolio might be, our top analysts put together a report on a group of high-yielding stocks that should be in any income investor's portfolio. To see our free report on these stocks, just click here now.

 

Rupert Hargreaves owns shares of Altria Group. The Motley Fool has no position in any of the stocks mentioned. 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.

1 Key Step to Get Rich

Our mission at The Motley Fool is to help the world invest better. Whether that’s helping people overcome their fear of stocks all the way to offering clear and successful guidance on complicated-sounding options trades, we can help.

Feb 1, 2016 at 4:54PM

To be perfectly clear, this is not a get-rich action that my Foolish colleagues and I came up with. But we wouldn't argue with the approach.

A 2015 Business Insider article titled, "11 websites to bookmark if you want to get rich" rated The Motley Fool as the #1 place online to get smarter about investing.

"The Motley Fool aims to build a strong investment community, which it does by providing a variety of resources: the website, books, a newspaper column, a radio [show], and [newsletters]," wrote (the clearly insightful and talented) money reporter Kathleen Elkins. "This site has something for every type of investor, from basic lessons for beginners to investing commentary on mutual funds, stock sectors, and value for the more advanced."

Our mission at The Motley Fool is to help the world invest better, so it's nice to receive that kind of recognition. It lets us know we're doing our job.

Whether that's helping the entirely uninitiated overcome their fear of stocks all the way to offering clear and successful guidance on complicated-sounding options trades, we want to provide our readers with a boost to the next step on their journey to financial independence.

Articles and beyond

As Business Insider wrote, there are a number of resources available from the Fool for investors of all levels and styles.

In addition to the dozens of free articles we publish every day on our website, I want to highlight two must-see spots in your tour of fool.com.

For the beginning investor

Investing can seem like a Big Deal to those who have yet to buy their first stock. Many investment professionals try to infuse the conversation with jargon in order to deter individual investors from tackling it on their own (and to justify their often sky-high fees).

But the individual investor can beat the market. The real secret to investing is that it doesn't take tons of money, endless hours, or super-secret formulas that only experts possess.

That's why we created a best-selling guide that walks investors-to-be through everything they need to know to get started. And because we're so dedicated to our mission, we've made that available for free.

If you're just starting out (or want to help out someone who is), go to www.fool.com/beginners, drop in your email address, and you'll be able to instantly access the quick-read guide ... for free.

For the listener

Whether it's on the stationary exercise bike or during my daily commute, I spend a lot of time going nowhere. But I've found a way to make that time benefit me.

The Motley Fool offers five podcasts that I refer to as "binge-worthy financial information."

Motley Fool Money features a team of our analysts discussing the week's top business and investing stories, interviews, and an inside look at the stocks on our radar. It's also featured on several dozen radio stations across the country.

The hosts of Motley Fool Answers challenge the conventional wisdom on life's biggest financial issues to reveal what you really need to know to make smart money moves.

David Gardner, co-founder of The Motley Fool, is among the most respected and trusted sources on investing. And he's the host of Rule Breaker Investing, in which he shares his insights into today's most innovative and disruptive companies ... and how to profit from them.

Market Foolery is our daily look at stocks in the news, as well as the top business and investing stories.

And Industry Focus offers a deeper dive into a specific industry and the stories making headlines. Healthcare, technology, energy, consumer goods, and other industries take turns in the spotlight.

They're all informative, entertaining, and eminently listenable ... and I don't say that simply because the hosts all sit within a Nerf-gun shot of my desk. Rule Breaker Investing and Answers contain timeless advice, so you might want to go back to the beginning with those. The other three take their cues from the market, so you'll want to listen to the most recent first. All are available at www.fool.com/podcasts.

But wait, there's more

The book and the podcasts – both free ... both awesome – also come with an ongoing benefit. If you download the book, or if you enter your email address in the magical box at the podcasts page, you'll get ongoing market coverage sent straight to your inbox.

Investor Insights is valuable and enjoyable coverage of everything from macroeconomic events to investing strategies to our analyst's travels around the world to find the next big thing. Also free.

Get the book. Listen to a podcast. Sign up for Investor Insights. I'm not saying that any of those things will make you rich ... but Business Insider seems to think so.


Compare Brokers