Unlike U.S. government bonds -- which offer investors a stated rate of interest from purchase through their maturity -- a stock that offers a dividend is often expected to grow that dividend over time. In other words, investors are willing to buy a stock with a dividend yield below the low-risk interest rate of U.S. treasuries because they believe that payout can increase in the future.
So, generally speaking, when a stock offers a dividend yield of 5% or higher, which is currently equal to or greater than the rate from most U.S. treasuries, it implies that investors think the business will either grow slowly or not at all. But for Philip Morris International (PM -1.11%), that line of thinking could be misguided. Let's see why.
Getting back to growth
Philip Morris International is one of the world's largest tobacco companies by revenue. Led by its flagship brand Marlboro, Philip Morris has historically been highly dependent on the sale of cigarettes. However, as the number of cigarette smokers globally has declined over the last several decades, so too has Philip Morris' shipment volume. In fact, over the last 10 years, the company has seen shipment volumes decline by more than 31%. With this shrinking addressable market in mind, management has decided to shift its focus to alternative forms of nicotine consumption, but this time with its eye on lower-risk products.
In 2014, Philip Morris introduced a new product called IQOS, which heats tobacco instead of burning it. With this new technology reportedly lowering exposure to harmful chemicals, the Food and Drug Administration (FDA) authorized Philip Morris the ability to market IQOS as a "modified risk" product. With this reduced-risk designation, customers have been quickly adopting IQOS as an alternative to traditional cigarettes. In its most recent quarter, Philip Morris sold just over 31 billion heated tobacco units, which is almost triple the figure from five years ago.
To help boost this growing presence in the reduced-risk market, last year, Philip Morris acquired Swedish Match for roughly $16 billion. Now under the Philip Morris umbrella, Swedish Match is home to the leading oral-nicotine brand Zyn, which like IQOS has been granted a "modified risk" designation from the FDA. The Zyn brand has been growing rapidly in the U.S. market with quarterly shipment volumes up more than 100-fold in the last six years alone. Despite other large tobacco companies like Altria Group (MO -0.37%) trying to undercut Zyn on cost, Zyn has been able to maintain roughly 77% market share in the U.S. while even raising its prices.
Thanks to the success of Philip Morris' heated tobacco and oral-nicotine categories, the company's total shipment volumes have started to grow again, and smoke-free products now account for roughly 35% of total revenue.
A consistent dividend
Despite the decrease in Philip Morris' cigarette shipments over the last decade, the company has been able to raise prices to compensate for it. This has helped the company to generate growing revenue and steady operating income, even while it has been investing in new initiatives.
With this consistent stream of cash flow, management has been paying most of it back to shareholders. In fact, over the last ten years, Philip Morris has paid out roughly 90% of its earnings to its shareholders on average, and management continues to increase this dividend gradually.
PM Dividend Per Share (TTM) data by YCharts.
Today, the company pays out $1.27 per share in quarterly dividends, which on an annual basis is equal to 5.3% of the current stock price. That means as long as the dividend doesn't stop or decrease, buyers today are getting more than 5% of their purchase price back in cash every year.
A low-risk investment
Between the consistent profits from Philip Morris' cigarettes business and the impressive volume growth of the smoke-free portfolio, the tobacco giant looks poised to really accelerate its earnings growth for the first time in a while.
With the stock trading at an enterprise value (market cap plus net debt)-to-EBIT (earnings before interest and taxes) multiple of just 17 times, and a management team that's committed to giving its cash flow back to shareholders through dividends, this feels like a great opportunity to own a durable business well-positioned for a smoke-free future.
