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How Philip Morris International Became a Top Dividend Stock

By Dan Caplinger - Jul 6, 2015 at 8:03AM

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In just a few short years, the tobacco giant has established itself as an income producer.

Tobacco farm. Image: Philip Morris International.

Dividend investors have often looked to the tobacco industry for high dividend yields, as the companies involved have historically traded at low valuations because of fears of legal and regulatory disruptions to their business models. In less than a decade, international tobacco specialist Philip Morris International (PM -0.23%) has established itself as a solid dividend player, with yields that reflect its solid success even in the face of some challenging conditions in the industry. Let's take a closer look at how Philip Morris International earned the strong reputation among dividend investors that it has now.

1. Philip Morris International was quick to establish a minimum dividend target based on earnings.
Many companies simply pay dividends based on their past payout history, paying little attention to how those payments relate to the success of the underlying business. Philip Morris defied that paradigm early on, with the tobacco company establishing a target payout ratio of 65% of earnings soon after it was spun off from its former parent. Over time, Philip Morris hasn't hesitated to lift its dividend above the 65% target, but investors have a sense that if earnings were to grow substantially, the company would nevertheless make sure it was paying enough to avoid going below the 65% payout ratio.

By linking dividends to earnings, Philip Morris gives its investors a direct payoff when times are good. Recently, Philip Morris International's dividend growth has slowed, as earnings have taken a hit from the strong dollar and other challenges in the industry. Once dollar-related headwinds dissipate, though, Philip Morris could easily see its quarterly dividends grow at the faster rate the stock enjoyed throughout its initial years as an independent stock.

2. Strong brand presence gives Philip Morris pricing power.
In the U.S., cigarette sales volumes have fallen gradually over time, and part of the initial appeal of Philip Morris was that investors saw its international exposure as a way to find growth. That hope turned out to be overly optimistic, as many of the same factors that hurt U.S. tobacco sales have also hit foreign countries. Nevertheless, Philip Morris has been able to make the most of a tough market by imposing price increases in many areas, and the reason it's able to do so is that it has well-known brands and its customers are loyal to those brands.

Marlboro drives Philip Morris International's overall results, but the company also has some other brand names that have seen varying degrees of success. With brands like L&M, Parliament, Bond, and Chesterfield, Philip Morris International has been able to broaden its appeal to a wider demographic in the tobacco market, and the resulting sales have allowed Philip Morris to keep its dividend growing over time.

3. Philip Morris has committed to dividends over other methods of returning shareholder capital.
During good times, Philip Morris International earned a reputation for giving capital back to shareholders not only through high dividends but also via stock repurchases. The company spent $3.8 billion on buybacks in 2014 and nearly $6 billion in 2013. Yet this year, the company said that it would bring its repurchase activity to a standstill in light of the drop in free cash flow that Philip Morris has seen recently.

Falling free cash flow certainly isn't good news, but dividend investors still like to hear that Philip Morris International wants to make sure that it doesn't spend so much on buybacks that it leaves the company without the resources it needs to keep paying and growing its regular dividend. Once currency-related challenges and other factors holding back Philip Morris International's earnings growth start to subside, the international tobacco giant should be able to reward shareholders in multiple ways once again.

Even though it hasn't been a public company very long, Philip Morris International has earned its solid reputation as a high-yield dividend stock. Investors who are hungry for income should expect further good news from Philip Morris for many years to come.

Dan Caplinger 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.

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