Please ensure Javascript is enabled for purposes of website accessibility

How Safe Is Philip Morris International Inc.'s Dividend?

By Andrés Cardenal - Jul 29, 2015 at 8:00AM

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

Philip Morris stock pays a big dividend yield of 4.7%, however, tobacco is a particularly risky industry.

Source: Philip Morris.

Philip Morris International (PM 0.99%) stock offers many valuable traits for dividend investors. For starters, the stock pays a big 4.7% dividend yield, and the company has delivered consistent dividend growth over the years. On the other hand, tobacco is a very particular industry, exposing investors to considerable risks. This raises a big question for investors: How safe are the dividends from Philip Morris?

Hot dividend growth
Tobacco is a remarkably profitable industry, especially for a company such as Philip Morris, which owns the international rights to powerful brands such as Marlboro, Parliament, L&M, and Chesterfield, among others.

Consumers are typically very loyal to their preferred cigarette brand, and management estimates that Philip Morris has market share of 40.4% in Europe, 27.6% in Russia, and 25.4% in Japan. When considering the company's top 30 markets in terms of operating companies income, or OCI, Philip Morris owns a total market share of 37.5%.

Tobacco companies face serious regulatory limitations when it comes to marketing and advertising, and this can be a considerable advantage for a market leader such as Philip Morris, since bans on advertising keep market share levels relatively stable and potential new entrants at bay.

The business generates big profit margins in the neighborhood of 39% of revenues at the operating level, and reinvestment needs are relatively low, allowing Philip Morris to build a rock-solid track record of dividend growth over the years.

Philip Morris has been independently traded and operated since 2008, when the company was separated from Altria through a spinoff. Back then, Philip Morris was paying a quarterly dividend of $0.46 per share, and distributions have increased consistently every year, more than doubling to $1 per share currently.

Looking forward
A solid trajectory of dividend growth says a lot about a company's financial strength and management's commitment to rewarding shareholders with growing payments over time. However, investment decisions need to be based on forward-looking considerations, not past performance, so it's important to to keep a close eye on the main industry trends and how they can affect Philip Morris' dividends in the future.

Governments and nonprofit organizations are implementing all kinds of initiatives to combat smoking and its negative impact on public health. Tobacco consumption around the world is on a secular decline, and Philip Morris is not immune to this trend.

Philip Morris' total cigarette sales volume declined from 927 billion units in 2012 to 880 billion in 2013, and then to 856 billion cigarettes in 2014. This represents a year-over-year decline of 5% in 2013 and 3% in 2014.

Management calculates that industry volume in the second quarter of 2015 declined by 3% year over year, and the company is forecasting a decline of between 3% and 3.5% in total industry volume during 2015. However, Philip Morris is outperforming the industry on the back of strong brand power and market share gains, so the company's organic sales volume declined only 1.4% during the last quarter.

Unfavorable currency movements are hurting the company's revenues when measured in U.S. dollars, but sales in constant currency are still growing because of pricing gains. Net sales excluding currency fluctuations and acquisitions grew 4.5% in the second quarter, and management reaffirmed its guidance for an annual increase of between 9% and 11% in constant currency earnings per share for the full year 2015.

It's nice to see Philip Morris compensating the decline in sales volume with price increases and expanding profit margins. However, it's hard to tell for how long this trend can be sustained. After all, you can't keep raising prices and cutting costs indefinitely. Sooner or later, the decline in volume will cut into sales and cash flows unless the company can find new growth venues.

Companies in the industry are betting on e-cigarettes to replace traditional ones, and Philip Morris is moving in the same direction. The company is rolling out its iQOS device in Japan and Italy, and management sounds quite enthusiastic about the potential opportunity in e-cigarettes. However, the jury is still out regarding the health impact of these products, and they're unlikely to have a big financial impact over the middle term.

Philip Morris produced nearly $6.5 billion in free cash flow during 2014. Dividends consumed $6 billion over the year, so current distributions are sustainable, but the company doesn't have much room to raise payments without issuing debt. That means dividend growth should be in line with sales and cash flow growth in the years ahead.

There's no reason to expect a dividend cut from Philip Morris anytime soon, but dividend growth will probably be subdued in the coming years. Longer-term, falling sales volume is a major risk to keep in mind.

Invest Smarter with The Motley Fool

Join Over 1 Million Premium Members Receiving…

  • New Stock Picks Each Month
  • Detailed Analysis of Companies
  • Model Portfolios
  • Live Streaming During Market Hours
  • And Much More
Get Started Now

Stocks Mentioned

Philip Morris International Inc. Stock Quote
Philip Morris International Inc.
$99.72 (0.99%) $0.98
Altria Group, Inc. Stock Quote
Altria Group, Inc.
$42.25 (1.15%) $0.48

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

Related Articles

Motley Fool Returns

Motley Fool Stock Advisor

Market-beating stocks from our award-winning analyst team.

Stock Advisor Returns
S&P 500 Returns

Calculated by average return of all stock recommendations since inception of the Stock Advisor service in February of 2002. Returns as of 07/04/2022.

Discounted offers are only available to new members. Stock Advisor list price is $199 per year.

Premium Investing Services

Invest better with The Motley Fool. Get stock recommendations, portfolio guidance, and more from The Motley Fool's premium services.