Can Tobacco Company Dividends Stay High? (MO, PM, BTI, RAI, LO, VGR)

Some of the highest dividend-paying stocks have been the tobacco companies. Altria Group Inc. (NYSE: MO), Philip Morris International Inc. (NYSE: PM), British American Tobacco plc (AMEX: BTI), Reynolds American Inc. (NYSE: RAI), Lorillard, Inc. (NYSE: LO), and Vector Group Ltd. (NYSE: VGR) have posted solid dividend yields for the past year, and the only issue now is whether or not the companies can keep it up.

Here’s a quick chart of trailing twelve-month annual dividend yield and forward annual dividend yield as of Friday’s close, together with the stocks’ 52-week ranges and median share price target.

In a sign that some analysts are losing confidence in the tobacco sellers, Citigroup has downgraded British American and Philip Morris from ‘Buy’ to ‘Hold’. Citi expects smoking to essentially disappear in the next 30 to 50 years. The analyst doesn’t offer a reason for the disappearance, but the logical conclusion is that all smokers will be dead by then.

Even if that’s true, the short-term focus is more important to investors than the outlook for 20 years from now, and the forward yields for the tobacco companies are higher for every company except Reynolds American. That suggests that overall expectations for the tobacco business are still strong.

The reason for the continuing growth projections have to do with the very nature of tobacco itself. In “Barbarians at the Gate,” the story about the takeover of RJR Nabisco back in the late 1980s, one of the tobacco company executives is quoted as saying something like this:

“Cigarettes are the perfect product. You can make them for a penny and sell them for a dollar; people are seriously brand loyal; and the product is addictive.”

The risks of owning a tobacco stock are not insignificant. More litigation, higher excise taxes, more government regulation, and dying customers don’t offer a welcoming environment.

But the tobacco firms’ pricing power is outrageous, especially Altria’s and its Marlboro brand. Marlboro’s US market share is over 40% and the brand sells at a premium of more than 30% to lower cost cigarettes.

Altria’s forward dividend yield is higher than any other, except Vector Group’s. Vector introduced and still makes many discount cigarette brands. The company is smaller than the others we’ve looked at here, but its expected dividend yield is hard to ignore.

Investors untroubled by sin can’t do much better than either Altria or Vector Group. Or is that, can’t do much worse.

Paul Ausick