In recent weeks, income investors have suffered from a rash of dividend cuts. The vast majority of these cuts are taking place in the energy sector: a direct result of the collapse in oil prices.
But the fears of dividend cuts are spreading to other types of businesses, as well. In the consumer staples sector, one stock that has drawn scrutiny about the sustainability of its dividend is tobacco manufacturer Philip Morris International (NYSE:PM).
Philip Morris is suffering through a very tough time. Primarily, the company is being hit with an unprecedented currency headwind. These forces are causing the company's earnings to fall -- and with a 5% dividend yield, some are wondering whether the dividend is on the chopping block.
Fortunately, Philip Morris' management is putting several measures into place that will raise billions of dollars in cash. Investors should know that even in this difficult climate, the company should still generate enough profit to keep its dividend intact.
2014: A year to forget
During the past year, changes in the currency market have taken a huge bite out of Philip Morris International. The U.S. dollar has risen dramatically against other currencies including the euro, which is a big problem for large multinational companies such as Philip Morris. The strengthening dollar makes international sales worth less when that revenue is converted back into the domestic currency.
Due mostly to unfavorable currency fluctuations, Philip Morris International's revenue and earnings per share fell 4.6% and 9.5%, respectively, in 2014. Currency fluctuations shaved a whopping $0.80 per share, or approximately $1.2 billion, off Philip Morris' full-year earnings per share.
Excluding currency, the company actually performed well. Its earnings per share would have increased by more than 5% last year. Still, the currency issue is having a real impact, and this headwind is expected to persist going forward. Management believes ongoing currency effects will deduct a very significant $1.15 per share from earnings in 2015.
Concern has now turned to the dividend. During the past year, Philip Morris International's dividend yield has spiked from a low of close to 4% late last year to its current level of 5%.
As you can see, this was directly due to its falling share price during this time.
Dividend appears secure
Before investors get carried away, it's important to remember that the company still generated enough cash flow to pay its dividend last year. In 2014, Philip Morris produced $6.5 billion in free cash flow and paid $6 billion in dividends.
Going forward, Philip Morris International is enacting several initiatives to conserve cash in order to withstand a further decline in free cash flow. First, the company will not buy back any stock this year. This should free up a significant amount of cash, because Philip Morris spent $3.8 billion on share repurchases last year, and $5.9 billion the year before.
In addition, there are strict cost controls in place. Last year alone, the company reduced costs by $300 million, with further productivity measures set for this year.
This year, management expects earnings per share to fall to between $4.27 per share and $4.37 per share. At the same time, the company's dividend totals $4 per share annually. As you can see, even though 2015 is expected to be another tough year, the company's payout ratio will remain below 100%.
The key takeaway for investors is that even though Philip Morris International is suffering falling profit and free cash flow, the dividend does not appear at risk. The company generates enough free cash flow to sustain its dividend, and management is taking several steps to produce even more cash. Bottom line, the dividend appears secure.