3 Tobacco Stocks for Dividend Investors

Image source: Philip Morris.

This article was originally published on October 27, 2015 and was updated on May 24, 2016.

Tobacco is a very particular business; tobacco stocks expose investors to considerable risks due to an increasingly adverse regulatory environment and the long-term decline in global tobacco consumption. On the other hand, the tobacco business is also remarkably profitable, and big tobacco stocks generate tons of cash flow, which they consistently distribute to investors via growing dividends over time. Here's a list of three top tobacco stocks:

Source: Yahoo Finance

With this in mind, let's go over the latest dividend increases from Altria, Reynolds American, and Philip Morris in order to find out what the three tobacco giants have to offer to dividend investors going forward.

Smoking-hot dividends from Altria

Altria owns the rights to the Marlboro brand in the U.S., and this provides the company with a dominant competitive position, since Marlboro owns more than 44% of the U.S. cigarette retail market. In addition, the company has a presence in other businesses such as smokeless tobacco, wine, and, importantly, a 27% stake in SABMiller.

However, cigarettes still account for nearly 90% of Altria's revenue, and the company is leveraging its brand power and economies of scale to drive growing cash flows from this business over time. Cigarette sales volume in the U.S. have been declining by between 3% and 4% annually over the last several years, but Altria has managed to sustain sales at stable levels on the back of pricing gains. Due to low reinvestment needs and cost efficiencies, the company is able to produce consistently rising profit margins, and management is expecting adjusted earnings per share to increase between 7.5% and 9.5% during 2015.

Altria is committed to distributing 80% of adjusted earnings to investors via dividends, and the company announced in July a new share buyback program for $1 billion, which management expects to complete by the end of 2016. When including both dividends and buybacks, Altria has returned more than $16 billion to investors from the end of 2011 through June 30, 2015.

The company raised dividends by 8.7% this year, to $0.565 quarterly per share. The stock pays a dividend yield of around 4.2% at current prices, and Altria should be able to sustain dividend growth in line with earnings per share expansion in the coming years, which will probably be in the mid-to-high single digits. 

Reynolds American for dividend growth

Reynolds American has recently completed a transformative merger with Lorillard, and this move consolidated the company in second position in the U.S. tobacco industry behind Altria. Reynolds American now owns three strong brands in the U.S: Newport, Camel, and Pall Mall, which account for nearly 13%, 10%, and 9.5% of retail sales in the industry. Besides, the company is actively investing for innovation in areas such as e-cigarettes and smokeless tobacco with products such as its Vuse e-cig and Revo heat-not-burn.

Reynolds American is delivering rock-solid financial performance, net sales grew 11.1% to $2.4 billion in the second quarter of 2015, and adjusted earnings per share increased 14.6% year over year. Management also raised its earnings per share guidance for the full year 2015, from $1.83-$1.9 to $1.9-$2.

Reynolds American announced a 7.5% dividend increase in 2015, raising dividends to $0.36 per share. The dividend payout ratio represents between 72% and 76% of the company's earnings guidance for this year, and the dividend yield stands at 3.4%.

Reynolds American comes substantially behind Altria in dividend yield, but the company could outperform the industry leader terms of dividend growth in the middle term since it has more room for market share gains and the dividend payout ratio is a bit lower.

Philip Morris for international dividends

Philip Morris owns the international rights to powerful brands such as Marlboro, Parliament, L&M, and Chesterfield, among others. The company has been independently traded and operated since 2008, when it was separated from Altria through a spinoff. Back in 2008, 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. 

However, dividend growth significantly slowed down in 2015, Philip Morris raised dividends by only 2% this year. The main reason behind this deceleration is currency headwinds, since depreciating global currencies are hurting Philip Morris' earnings and cash flows when translated to U.S. dollars. 

On the other hand, the business is still fundamentally strong when leaving currency considerations aside. Sales excluding currency fluctuations and excise taxes increased 5.6% during the third quarter in 2015, and the company raised its earnings per share guidance for the full year. Management is expecting currency neutral earnings per share to rise between 11% and 12% versus 2014 levels.

Philip Morris has a dividend payout ratio in the neighborhood of 90% of earnings guidance for 2015, so dividend growth could remain subdued if currency headwinds continue weighing on the business. On the the other hand, the company beats Altria and Reynolds American with a big dividend yield of 4.7%.