How Sustainable Is This Income Investment's Dividend?
Tobacco companies like Philip Morris International and Altria Group are well known for their shareholder returns. Indeed, tobacco companies are often quoted as some of the most defensive stocks you can find in the market thanks to their great dividend yields. However, with the number of smokers worldwide in terminal decline, how safe are these payouts?
Tobacco companies did not get the reputation they have today by breaking their commitment to dividend payouts. For example, dividend payouts of both Altria and Universal Corp have been continually growing for more than 40 consecutive years.
Actually, Philip Morris' management has been extremely prudent in ensuring the long-term sustainability of the company's dividend. In particular, after Philip Morris spun off from what is now Altria during 2008, for its first full year of independence the company generated $8.1 billion in funds from operations, from which it paid out $5.1 billion in dividends to investors.
Now Philip Morris could have paid out a lot more than this in theory, but it remained cautious, paying out only what it believed it could afford. Since then the company's payout has edged up, rising from an initial quarterly payout of $0.46 per share in 2008 to a quarterly payout of $0.94 per share as of the third quarter of this year.
However, while the payout has more than doubled, it has only grown in-line with funds generated from operations.
Funds from operations
Dividends paid out
As we can see, Philip Morris' payout has risen more than 100% on a per-share basis during the past five years. Meanwhile, the company's payout ratio has, for the most part, remained below 60% of funds from operations. All in all this indicates that Philip Morris' payout is quite safe, with plenty of room for further growth.
This kind of prudence is exactly what sustainable dividends are built on. American States Water has one of the longest dividend-payout histories you can find, as the company has been paying out and raising its dividend for 58 consecutive years. Actually, American States has many similar traits to Philip Morris. Specifically, the company is highly cash generative, reporting a gross margin of 84% for fiscal 2012, has low requirements for capital spending, and operates within a fairly defensive industry--the provision of water and related services.
Furthermore, American States has increased its dividend payout 60% during the past 10 years; that's a compound annual growth rate of 5.4%, which is not spectacular but is above inflation. However, during this period, the company has only paid out an average of approximately 30% of cash from operations in dividends. This has allowed the company to slowly increase its payout, building up trust with investors and keeping the payout moving higher.
With only 30% of cash from operations paid out on average per year, American States has plenty of headroom to keep its payout moving higher for many years to come -- even if things turn against the company. This is exactly the same strategy that Philip Morris is pursuing.
Cast from the same mold
But with Altria and Philip Morris being cast from the same mold, it is unusual to see that Altria's dividend payout is under much more pressure than that of its larger, international peer.
Specifically, for the last five years, Altria has paid out a total of $16.7 billion in dividends. During the same period, the company has only generated funds from operations of $18.2 billion, a payout ratio of close to 92%. These figures make me anxious about Altria's dividend future, as it would appear that the company has little room to be able to sustain the payout if things go wrong.
That being said, Altria, and previously Philip Morris, has been returning cash to shareholders for more than four consecutive decades, so I would hesitate to suggest that the company's payout is in trouble. If we exclude 2012, which was a bad year for Altria income-wise due to exceptional taxation charges, the company's payout ratio for the previous four years drops to 85%. So, I would like to see some more years of future data before I can conclude that the company's payout is unsustainable.
Nevertheless, Altria has increased its payout 47 times during the last 44 years, and the company aims to return 80% of diluted earnings per share to investors ever year, which gives me confidence in the company's payout future.
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The article How Sustainable Is This Income Investment's Dividend? originally appeared on Fool.com.Fool contributor Rupert Hargreaves owns shares of Altria Group. The Motley Fool owns shares of Philip Morris International. 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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