Long a mainstay of dividend investors' portfolios, Philip Morris (PM 1.80%) now suffers from newfound doubts about the tobacco giant's future. The stock is down slightly year-to-date even as the broader market surged 11.5% over the same period. Disturbances in Asian markets and heftier regulation in European markets have stifled Philip Morris' growth. However, there are four good reasons why Philip Morris is still a safe stock for dividend portfolios. Read on to find out why Philip Morris still puts Altria Group (MO 1.68%) and other dividend stocks to shame.
Still room to grow sales
Cigarette volume is the biggest long-term headwind for Philip Morris' dividend. Even as the world population has continued to grow, higher taxes and tighter regulation constrained cigarette sales over the past decade. Philip Morris experienced its worst volume decline in 2013, when it sold 5.1% fewer sticks than in 2012.
Despite the decline, investors have two good reasons to be optimistic about cigarette volume going forward. First, 2013 volume declined just 2.7% excluding the Philippines. Philip Morris' Philippine sales have been plagued by a large tax increase that it claims is not being paid by its primary rival in the region. However, steps have since been taken to curb the alleged tax evasion, thereby, Philip Morris hopes, leveling the playing field.
Second, growth opportunities still abound in Asian markets, along with countries in the Middle East and Africa. Asia already accounts for 33.6% of Philip Morris' operating income, while Eastern Europe, Middle East, and Africa account for 27.4%. Continued growth in these densely populated regions may offset further declines in Western Europe.
Cash flow increasing
In addition to flattening volume, Philip Morris may benefit from higher prices in the coming years. The company has traditionally been able to raise prices faster than volume has declined, resulting in prodigious growth in cash from operations.
If Philip Morris' Marlboro and other premium brands maintain pricing power – and if cigarette volume remains stable – future cash flow growth may be equally impressive. The addictiveness of cigarettes makes it likely that most current Marlboro smokers will continue buying the brand without significant regard for the price. As a result, Philip Morris' premium cigarette brands should retain their pricing power even in the face of emerging substitutes. This will generate more cash to pay higher dividends.
Payout ratio remains low
Not only is Philip Morris growing cash flow, it also pays out a lower percentage of available cash flow than its peers. Over the last four quarters, Philip Morris paid dividends equivalent to 69% of its cash from operations, compared to Altria's 84% cash payout ratio.
Philip Morris' relatively low payout ratio is better than Altria's higher ratio because it gives Philip Morris room to raise its dividend even if cash flow stumbles one year or doesn't grow as quickly as expected. As a result, investors can be confident that Philip Morris' history of dividend raises will continue uninterrupted for the foreseeable future – providing crucial protection for income investors. Philip Morris currently pays a $4-per-share annual dividend. Five years ago, the stock was paying $2.32 per share per year in dividends.
Having established that Philip Morris has high and growing cash flow and a relatively low payout ratio, it's time to evaluate the company's dividend yield. The board announced a 6.4% dividend increase in the third quarter; it now pays a $1-per-quarter dividend.
With the stock trading around $87 per share, investors can buy in at a 4.6% dividend yield. That's higher than Altria's dividend yield, currently at 4.1%. In fact, Philip Morris' yield puts it solidly in the top-half of all dividend stocks. The dividend yield of all S&P 500 stocks sits at 1.86%, while the median yield is 4.35%. Investors would be hard-pressed to find a higher yield that is as safe as Philip Morris', making the tobacco giant a solid addition to any dividend portfolio.