Big tobacco companies such as Philip Morris (NYSE:PM), British American Tobacco (NYSEMKT:BTI), and Altria (NYSE:MO) are known for making generous capital distributions to shareholders, and this is among the main reasons why investors are attracted to these companies. However, declining demand is a major hurdle for the industry, and dividend payments could be under pressure in the years ahead.
Philip Morris is an industry leader benefiting from a dominant presence in emerging markets from top brands such as Marlboro and Philip Morris. However, falling tobacco sales have become a material difficulty for the company lately.
Cigarette shipment volume declined by 4.4% year over year during the first quarter of 2014, to 196 billion units. Revenue fell 8.8% to $6.9 billion, while revenue excluding currency fluctuations declined by 1.6%.
Sales excluding currency fluctuations are still growing in Latin America and Canada, with an increase of 4.2% during the last quarter. The Eastern Europe, Middle East, and Africa region is another growth market for Phillip Morris, as sales increased 4.5% when excluding currency fluctuations.
On the other hand, revenue adjusted for currency volatility fell by a big 8.7% in Asia -- the company´s biggest market in terms of operating profits -- and declined by a more moderate 0.8% in the European Union.
Philip Morris pays a dividend yield of 4.2%, and the company repurchased 15.4 million shares for $1.25 billion during the first quarter.
Management intends to maintain the dividend payout ratio in the area of 65% of earnings in the long term, but the current dividend represents approximately 72% of average earnings estimates for 2014.
Philip Morris is reaching the upper limit of its target dividend payout ratio; unless the company can substantially accelerate earnings growth in the coming years, there are not many reasons to expect big increases in capital distributions from Philip Morris over the long term.
British American Tobacco
British American Tobacco owns several well-recognized brands targeting different segments of the pricing spectrum, including names such as Dunhill, Kent, Pall Mall, and Lucky Strike. The company reported a decline of 12% in revenue during the first quarter, although sales in constant currencies declined only 2% during the period.
Total tobacco volume declined 1.2% year over year during the quarter, to 164 billion units versus 166 billion units in the first quarter of 2013. Sales volume in the Asia-Pacific region increased by 4.2% to 50 billion units, but the company suffered volume declines in the Americas, Western Europe, and Eastern Europe, Middle East, and Africa regions.
British American Tobacco pays a dividend yield of 5.4%, but the payout ratio in the area of 75% of earnings does not leave much upside room.
With the dividend payout ratio at extended levels and earnings growth limited by falling demand, dividend payments from British American Tobacco could be under pressure over the coming years.
Altria is the top player in the U.S. tobacco industry thanks to the strength of its Marlboro brand, which owns approximately 43.8% of the market and is bigger than the next 11 cigarette brands combined. On the other hand, tobacco sales in the U.S. are on a long-term secular decline, and Altria does not have the same presence in emerging markets as Philip Morris and British American Tobacco.
Cigarette shipment volume declined by 2.5% in the first quarter, to 28.75 billion units. Sales of Marlboro products fell 2.4% to 24.8 billion, while other premium brands declined 8.6% to 1.6 billion and discount cigarette sales increased 0.9% to 2.3 billion. Total revenue fell 0.2% versus the same period in the prior year, to $5.5 billion.
Altria pays a dividend yield of 4.6%. Wall Street analysts on average forecast $2.57 in earnings per share for the company during 2014, so the quarterly dividend of $0.48 represents a payout ratio in the area of 75% of earnings.
Like its peers, Altria seems to be reaching a limit in terms of dividend payout ratio, and prospects for growth in the industry are not precisely encouraging, especially in the U.S.
Falling demand is a major problem for tobacco companies, as price increases and cost savings can only go so far in sustaining earnings. With Philip Morris, British American Tobacco, and Altria distributing a big percentage of earnings in dividends, it looks like capital distributions could be under pressure over the coming years. Unless there is a material change in industry dynamics, tobacco dividends don´t look very healthy.
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Andrés Cardenal has no position in any stocks mentioned. 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.