The best consumer staples stocks have the unique ability to pay high dividend yields to shareholders as well as raise their dividend payouts each year, regardless of the state of the economy. Since their strong brands enjoy high demand from consumers year in and year out, they can remain highly profitable, even during economic downturns.
Tobacco giant Altria Group Inc. (MO, Financial) has increased its dividend 53 times over the past 49 years, including a 14% hike on Aug. 23. The dividend increase elevates the company's dividend yield to 5.5%, which is a highly attractive payout. Altria offers more than twice the dividend yield as the average S&P 500 stock.
In addition, the company's market-leading brand and new growth initiatives should allow it to raise its dividend for many years to come.
A cash flow machine
Altria was founded by Philip Morris (PM, Financial) in 1847. Today, it is a consumer staples giant with several highly popular brands. It sells the Marlboro cigarette brand in the U.S., which holds the top domestic market share. The company also has a number of non-smokeable brands, including Skoal and Copenhagen chewing tobacco and Ste. Michelle wine. Altria also has a 10% ownership stake in global beer brewer Anheuser-Busch Inbev (BUD, Financial).
Legendary investor Warren Buffett (Trades, Portfolio) once said, “I’ll tell you why I like the cigarette business. It cost a penny to make. Sell it for a dollar. It's addictive. And there's a fantastic brand loyalty”. These qualities have made Altria a hugely successful business model over the last several decades. With low costs of production and distribution, huge brand equity and the ability to raise prices over time, the company generates massive amounts of free cash flow. For instance, the company generated $4.92 billion in operating cash flow in 2017. The company required just $199 million for capital expenditures that year, which resulted in free cash flow of $4.72 billion.
The high free cash flow generation fuels Altria’s impressive dividend growth history. In the second quarter, the company’s adjusted earnings per share increased 19% from the year-ago quarter. Revenue net of excise taxes declined 5.4% due to the continued decline in the smoking rate. Altria’s cigarette shipment volume declined 5%, which was worse than the industry's 3.5% decrease. Regardless, Altria still managed to grow earnings via cost cuts, share repurchases and the benefit of a lower tax rate.
2018 should be another strong year. The company expects 16% to 19% earnings growth for the full year. Going forward, the major growth catalyst is product innovation. The smoking rate in the U.S. is declining, which has prompted Altria to invest in new product development. The company has invested heavily in non-combustible products that heat tobacco instead of burning it. According to Altria, these products have fewer harmful side effects and are designed to meet the needs of a changing consumer marketplace.
Altria’s new product line includes e-vapor and e-cigarettes. Its Nu Mark subsidiary grew shipments of e-vapor products by 16% last quarter, as the MarkTen Elite has been expanded to over 23,000 retail stores. It is also awaiting regulatory approval from the Food and Drug Administration for its new reduced-risk product line called IQOS, which holds great potential and could be the company's core product in the future.
A transparent dividend policy
Altria is a very shareholder-friendly company. Management has set a target dividend payout ratio of approximately 80% of its adjusted diluted earnings per share each year. The new annualized dividend rate is $3.20 per common share. Based on the company’s 2018 guidance for earnings per share in a range of $3.90 to $4.03, the dividend payout ratio is likely to be 79% to 82% this year, which is right on target.
As a result, the company's future dividend growth rate is likely to mirror its annual earnings growth rate. The combination of revenue growth from new products, share repurchases and margin expansion should provide it with at least mid-single-digit earnings growth each year.
Altria's stock is a unique blend of high dividend yield and high dividend growth. It is not easy to find stocks with 5%-plus yields that have the ability to raise their dividends by at least 10%. The company's industry-leading brand, combined with the strong economics of tobacco, make it a highly attractive stock for income investors.
Disclosure: I am not long any of the stocks mentioned in this article, but may purchase MO shares over the next week.
