Tobacco stocks might seem like risky investments, since smoking rates are declining worldwide. However, big tobacco companies excel at boosting their earnings with price hikes, job cuts, market consolidation, and stock buybacks.
That steady earnings growth enables them to pay out generous, dependable dividends -- making them ideal long-term investments for conservative income investors. Let's take a closer look at the top four dividend-paying tobacco stocks on the market today.
Philip Morris International
Philip Morris International (NYSE:PM), the maker of Marlboro, is the world's largest publicly traded tobacco company in terms of enterprise value. PMI was spun off of Altria (NYSE:MO) in 2008, with the former handling the overseas businesses and the latter becoming a purely domestic play. This move let PMI generate higher sales from overseas markets with higher smoking rates, but the strong dollar has become a major headwind in recent years. Nonetheless, analysts expect PMI's revenue and earnings to respectively grow 6% and 8% this year.
PMI currently trades at 25 times earnings, which is higher than the industry average of 21 for cigarette makers. As I mentioned in a recent article, that premium can be attributed to low interest rates lifting dividend stocks and the belief that its currency headwinds will fade. PMI pays a forward dividend yield of 3.7%, has a payout ratio of 92%, and has hiked its dividend every year since it split with Altria.
Altria, the biggest tobacco company in America, was intended to be a slower growth play than PMI, but its 140% gain over the past five years has crushed PMI's 30% return. That's because as a purely domestic play, Altria was insulated from overseas macro challenges and currency headwinds. Meanwhile, low oil prices and a strong U.S. economy boosted discretionary spending on products like cigarettes. Wall Street expects Altria's revenue and earnings to respectively rise 2% and 9% this year.
Altria trades at 10 times earnings, but that P/E is distorted by a big cash windfall from the sale of its stake in SABMiller to AB InBev last year. Its forward P/E of 21 is more in line with the industry average. Altria pays a forward yield of 3.2%, which is supported by a payout ratio of 32%. The company has also hiked its dividend every year since it spun off PMI.
British American Tobacco
London-based British American Tobacco (NYSE:BTI), which sells brands like Dunhill and Lucky Strike, is currently the third largest tobacco company after PMI and Altria. However, it it will claim the top spot once its acquisition of Reynolds American (NYSE:RAI) -- the fourth largest tobacco company in the world -- closes. Analysts expect BAT's revenue (excluding Reynolds' gains) to rise 7% this year, and for its earnings to grow 9%.
British American Tobacco trades at 21 times earnings. It pays a forward dividend yield of 3.4%, and has a payout ratio 63%. However, BAT pays uneven semi-annual dividends instead of uniform quarterly ones, but the total annual amount has risen over the past few years. Investors should also note that a weaker pound could reduce the dividend for ADR shareholders.
Imperial Brands (OTC:IMBBY), the Bristol-based company formerly known as Imperial Tobacco, is the sixth largest tobacco company in the world. It sells the Davidoff and West brands, along with a wide range of cigars, fine-cut tobacco, and tobacco papers.
When Reynolds acquired its rival Lorillard in 2015, Lorillard sold four brands -- its Blu e-cigarettes, Kool, Salem, and Winston -- to Imperial to appease regulators. That acquisition greatly strengthened Imperial's position in the U.S. market. Wall Street expects Imperial's revenue and earnings to respectively rise 23% and 10% this year, partly due to the weaker pound boosting its overseas revenues.
Imperial has slumped 13% over the past 12 months due to market consolidation and Brexit concerns, but it still isn't really cheap at 60 times earnings. The company's 5.6% forward yield looks attractive, but investors should note that its quarterly payments are uneven, currency headwinds apply, and it has a payout ratio of 215%. However, that dividend only used up 50% of its free cash flow over the past year, so it probably won't be reduced anytime soon.
But mind the long-term risks
Big tobacco companies are good at treading water and satisfying investors with buybacks and dividends, but investors should realize that this cycle is finite. Tobacco companies will eventually run out of ammo to offset declines in cigarette shipments, and new products like e-cigarettes probably won't grow fast enough to close the gap.
The market consolidation of giants like BAT and Reynolds could also put tremendous pressure on smaller players like Imperial Brands. Therefore, income investors should consider tobacco stocks good mid-term investments, but they should be ready to sell when they finally run out of ways to grow their earnings.