The U.S. stock market has just closed out one of its worst quarters in history. While it's impossible to call the bottom of a bear market, this may be an opportunity for income-hungry investors to snap up quality dividend payers at rock-bottom prices.

Philip Morris International (PM -0.15%) outperformed the wider market by only declining 14% in the first quarter, compared to a drop of 20% in the S&P 500. And the tobacco giant's 6.3% dividend yield is also significantly higher than the market average of 2%.

Philip Morris' payout looks sustainable based on its strong operating cash flow and immunity to coronavirus-related shocks. Rapid growth in the company's reduced-risk product segment looks set to make up for its declining combustible tobacco sales. But the tobacco maker's high payout ratio suggests that there is limited room for dividend growth.

Tobacco Industry


Can Philip Morris survive a downturn?

The coronavirus pandemic has sent the global economy into a tailspin as governments around the world order citizens to stay home and avoid non-essential activities to slow the spread of the deadly infection. These lockdowns have hurt companies that rely on selling goods and services. However, Philip Morris sells tobacco, which is an addictive product. And it is believed that tobacco consumption will hold up well in a wider economic downturn -- that's why tobacco companies are considered consumer staples.

According to analysts at RBC Capital, consumers in the U.S. are buying the same amount of tobacco products now as they were before the coronavirus crisis. A similar trend may be holding true in Europe, where tobacco shops are among the businesses allowed to remain open amid Italy's sweeping coronavirus lockdowns.

But that isn't to say tobacco is a growth market. According to the World Health Organization, the number of males using tobacco is declining globally due to government efforts to combat the deadly addiction. So while Philip Morris' combustible tobacco sales may hold up better than other consumer goods in a recession, the company will need to rely on new, safer products to power growth in the future.

Risk-reduced products are a major growth opportunity

Philip Morris is made up of two very different product segments. On one hand, there is the combustible products segment that sells regular cigarettes and cigars. And on the other hand, there is the reduced-risk segment that sells vaporizers and other combustion-free tobacco products. These segments have very different growth profiles.

In 2019, the reduced-risk category grew by 36.4% from $4.1 billion to $5.6 billion, while the combustible products segment fell 5.4% from $25.5 billion to $24.2 billion year over year.

Philip Morris is a stable company, but it isn't growing very fast. The tobacco maker reported annual net revenue growth (both segments combined) of 0.6% from $29.63 billion to $29.81 billion. This growth was driven by the massive jump in sales for reduced-risk products, which offset the declines in the much larger combustible products segment.

The breakneck growth in reduced-risk product sales should help Philip Morris stabilize its cash flow and maintain its large dividend. But with the larger combustibles business in decline, there isn't much room for dividend growth because operating cash flow has remained flat between $10.5 billion and 11.4 billion since 2015.

Dividend sustainability

Philip Morris recently declared a $1.17-per-share quarterly dividend, which comes out to $4.68 annually. If that holds all year, the company would continue its streak of raising its annual dividend every year since it went public in 2008. Paying out $4.62 per share last year cost the company $7.2 billion. The dividend has a payout ratio of 93% of net earnings and 71% of operating cash flow.

These numbers are quite high, but they are actually better than comparable firms in the tobacco industry. Altria Group, Philip Morris' North American spinoff, paid out $6.1 billion in dividends with $7.8 billion in operating cash flow in 2019. This gave Altria an operating cash flow payout ratio of 78% compared to 71% for Phillip Morris.

Philip Morris should be able to sustain its current disbursement because of its rapidly growing reduced-risk product segment and resistance to coronavirus-related shocks. But with cash flow flat over the last five years, the dividend's growth potential seems limited.