Better Tobacco Dividend: Altria or Philip Morris International?

By Markets Fool.com

Altria Group and Philip Morris International were once part of the same company. Altria Group held Philip Morris International as a subsidiary until 2008, when it was spun off. The rationale was that separating the international business would free it from the weight of a restrictive regulatory environment in the United States. Now that Philip Morris operates as an independent company, investors can choose between the two.

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In some ways, Altria and Philip Morris are still close cousins. They both offer similar products under the Marlboro brand. But that's about where the comparisons end. Altria and Philip Morris cater to different geographic markets, and their stocks offer different dividend yields. Collectively, their differences could make one of them a better choice than the other. Here is a head-to-head matchup using some key methods of comparison to help determine which tobacco dividend might be the better one to buy today.

Dividend yield
Perhaps the biggest reason investors buy tobacco stocks is for their high dividend yields. Indeed, both Altria and Philip Morris International offer dividend yields higher than the market average. Altria yields 3.8%, while Philip Morris' dividend stands at 4.8% currently. This might not seem like a big difference. After all, it's just one percentage point. But the extra income provided by Philip Morris does give it an edge for income seekers. Put differently, Philip Morris' dividend provides 26% more income than Altria, thanks to its higher yield.

Part of this discrepancy is due to their respective dividend growth over the past several years. Over the past five years, Altria has grown its dividend by 8% per year. By comparison, Philip Morris has been more aggressive. It's increased its dividend by 11% per year.

The other reason Altria's dividend yield has been pushed down is because its stock price has rallied considerably in recent years. In fact, in the past two years, Altria is up 59% while Philip Morris is down 6%. This has had a significant effect on their dividend yields, since a stock price and its dividend yield are inversely related.

As a result, when it comes to dividend yield and dividend growth, Philip Morris has the edge.

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Dividend sustainability
Philip Morris has a higher dividend yield and greater dividend growth than Altria, but the discussion doesn't end there. Analyzing a company's dividend sustainability is an important consideration as well. To do that, it's best to assess how much free cash flow a company generates, as it indicates whether the company will have the resources to continue to pay (or grow) the dividend in the future.

Altria generated $3 billion of free cash flow in the first three quarters of 2014, and paid $2.8 billion of dividends in that period. That means Altria's free cash flow payout ratio stood at 93%. Meanwhile, Philip Morris generated $5.5 billion in free cash flow in the first nine months of 2014, or about $3.58 per share. The company paid $2.88 per share in dividends during this time. This results in a free cash flow payout ratio of approximately 80%.

Both companies generate enough free cash flow to pay their dividends, but Altria is nearly distributing all of its free cash flow. Unless its operating cash flow improves or it reduces capital expenditures, Altria's very high payout ratio will inhibit its ability to grow its dividend as high as Philip Morris. For this reason, once again Philip Morris has the advantage.

Philip Morris may be the better tobacco buy
When evaluating dividend stocks, dividend yield is an important factor. However, equally important are the sustainability of the dividend and the ability of a company to grow its dividend over time. On all three measures -- dividend yield, dividend growth, and free cash flow payout ratio -- Philip Morris has the advantage.

Altria's stock has soared in recent years, while Philip Morris' has languished. This has richly rewarded Altria shareholders, but for those investors looking for the better dividend stock to buy right now, Philip Morris looks to have the edge over its former parent.

The article Better Tobacco Dividend: Altria or Philip Morris International? originally appeared on Fool.com.

Bob Ciura owns shares of Altria Group. 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.