Tobacco stocks have historically been extremely strong dividend stocks, and Philip Morris International (NYSE: PM) successfully followed in the footsteps of its former parent and its peers in the business for many years following its IPO in 2008. Yet more recently, Philip Morris has struggled to keep up the pace of its past dividend increases. After coming into 2016 hoping that the company would find a way to re-energize its dividend growth, investors in Philip Morris ended the year disappointed that the stock could only manage another minimal boost to its quarterly payout. Are the days of Philip Morris' dividend strength over? Let's take a closer look at what many see as Philip Morris' biggest disappointment of 2016.
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Image source: Philip Morris International.
Why dividend investors aren't all happy with Philip Morris
Philip Morris International did give its investors a dividend increase during 2016. However, the bad news was that the boost was just as small as it was in 2015, with the company deciding to implement a $0.02-per-share quarterly increase. That took the dividend up to $1.04 per share.
At first glance, that might not sound like such a bad thing. After all, the increase sent the yield on Philip Morris stock up to its current level of 4.5%. That's significantly higher than the dividend yields among major U.S. tobacco companies, and it's also more than some of its most important international competitors as well.
The problem, though, is that Philip Morris had historically done a much better job of giving dividend increases to its shareholders. Just take a look at the boosts that investors received in previous years:
Data source: Philip Morris International investor relations.
In that context, it's easier to understand the disappointment that some investors felt at Philip Morris' stingy decision with its dividend. Moreover, many of Philip Morris' peers in the tobacco industry have been able to sustain their dividend increases at levels consistent with past practice.
Two problems for Philip Morris
The most obvious problem that Philip Morris has faced in recent years has been the downward impact of foreign currency weakness on its financial results. Philip Morris reports its financials in U.S. dollar terms, but most major currencies around the world have weakened significantly against the dollar over the past couple of years. That has put pressure on Philip Morris' earnings, and it's a big part of why the current payout represents nearly all of the tobacco giant's earnings. Having such a high payout ratio isn't something Philip Morris wants, yet until currency markets sort themselves out, it could continue to be a challenge. Some trends earlier this year have been encouraging, but renewed strength in the dollar toward the end of 2016 could prolong the process further.
In addition, Philip Morris is also working on major initiatives to reinvent itself. The company itself has admitted that it could see a future without traditional cigarettes, and given how large a part of its business the cigarette market makes up, Philip Morris will have to work hard to adapt to changing conditions and consumer demand. That's a big reason why the tobacco giant has worked hard at developing reduced-risk products, and early results from its iQOS heat-not-burn technology have been promising. Yet even with impressive numbers from initial test markets like Japan, investors can't count on Philip Morris generating significant earnings from reduced-risk products without a long ramp-up period. Managing the transition from traditional cigarettes to other alternatives could be tricky, and anything that endangers Philip Morris' profitability in the near term will only serve to worry dividend investors further.
What's ahead for the tobacco company?
One sign of possible encouragement is that most investors see Philip Morris performing better in 2017. Projected growth in earnings is modest at just 7%, yet that would still be a big improvement over 2016 estimates of just 2% bottom-line growth. The consensus forecast for $4.81 per share in earnings for 2017 would reduce Philip Morris' payout ratio to 86% -- still on the high side, but not dangerously so.
Until that happens, though, Philip Morris International shareholders will have to deal with the sluggish growth in its dividend payout. Only if conditions improve fairly quickly in 2017 should investors anticipate much more than another token dividend increase next year.
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