The tobacco sector has long been favored by income investors. There is good reason why income investors seek out tobacco stocks in particular. Tobacco stocks typically have had high dividend yields, frequently well above 5%. They routinely offer dividend yields that far exceed the average yield of the broader stock market.
Many tobacco stocks have the added ability of raising their dividends on a regular basis, which has allowed investors to generate even greater dividend income over time. The combination of high dividend yields plus dividend growth are why tobacco stocks are held in such high regard among income investors.
This article will discuss 3 of our top tobacco stocks today that are particularly appealing for investors looking for high yields, plus long histories of dividend growth.
1. Altria Group
Altria Group (NYSE:MO) is the industry leader due to its flagship Marlboro brand, which by itself controls over 40% of U.S. retail market share. Altria is a more diversified company with recent expansions into smokeless tobacco, wine, and a ~10% ownership stake in Anheuser Busch Inbev (NYSE:BUD). That said, Altria still derives most of its revenue and profit from traditional cigarettes.
The decline in smoking is a persistent headwind for Altria, Altria’s adjusted cigarette volume decline rate came to 3% over the first half of 2020, worse than the industry volume decline of 1%. But the company has navigated this with price hikes and growth in non-cigarette products.
In the 2020 second quarter, Altria’s revenue declined 2.5% from the same quarter last year, as smokeable product volume declined 8.7%. On the plus side, Altria was able to generate expense reductions in the smokeable product segment to partly offset volume declines. The company also saw higher products in other areas over the first half of 2020, such as 10% revenue growth in oral tobacco products through the first six months.
Adjusted earnings-per-share increased 1% in the second quarter and 8.5% over the first half of the year. This continued growth allowed Altria to announce a 2.4% dividend increase along with the earnings release, the 51st consecutive year of a dividend raise. Altria is a Dividend King, an exclusive group of just 30 stocks that have each increased their dividend for at least 50 consecutive years. Altria has a high dividend yield of 8%. With a target dividend payout ratio of 80%, Altria’s dividend payout appears secure. Altria’s ability to grow investor’s income streams through dividend increases is one of the key differences of stocks versus bonds.
We expect Altria to continue growing future earnings, which will in turn fuel continued dividend increases. The company has invested in new categories such as cannabis and vaping, with investments in Cronos Group (NASDAQ:CRON) and JUUL Labs.
2. Philip Morris International
Philip Morris International (NYSE:PM) was spun off from Altria in 2008. It owns and operates production and distribution of Marlboro as well as a collection of other brands, outside the United States. In all, PM owns 6 of the world’s top 15 international cigarette brands—Marlboro, L&M, Chesterfield, Philip Morris, Parliament, and Bond Street.
Like Altria, PM has performed well to start 2020. While net revenue declined 0.5% in the first half, 5.4% growth in combustible tobacco pricing and cost reductions produced 8% growth in adjusted earnings-per-share. Revenue declines stemmed from weak volumes, as PM’s total shipment volume declined 8% in the first half.
But the company successfully passed along pricing increases and cost savings to offset volume declines, following a similar path as Altria. The strength and resilience of the Marlboro brand has helped both companies continue to generate earnings growth, even in an environment of declining smoking rates in the U.S. and elsewhere.
And like Altria, PM is betting its future on new products, although it is taking a slightly different route. Whereas Altria has diversified its portfolio to include adjacent categories such as wine, beer, vaping and cannabis, PM has invested heavily in development of heated tobacco product iQOS. Heated tobacco units, or HTUs, are increasingly important for PM as they now constitute over 10% of the company’s total volume.
PM understands the likelihood of a post-cigarette future, which is why the company’s core strategy is to switch smokers from cigarettes to its own iQOS product. PM has reported a high conversion rate of 70% for iQOS, which bodes well for the future.
In the meantime, PM continues to make its dividend among its top financial priorities. The company recently stated it is committed to maintaining the dividend, even now during a highly challenging climate. With a high yield of 6%, PM is an attractive income stock.
3. Universal Corporation
Universal Corporation (NYSE:UVV) is also an appealing stock for income investors, primarily because it has maintained a very long history of annual dividend increases. Universal recently increased its dividend for the 50th consecutive year, qualifying the company for inclusion on the Dividend Kings list. Universal also has a high dividend yield of 7%.
Universal is a slightly different business model than most tobacco companies like Altria and Philip Morris International. Universal is the world’s largest leaf tobacco exporter and importer. It is a wholesale purchaser and processor of tobacco that operates between farms and the companies that manufacture cigarettes, pipe tobacco, and cigars. Therefore, its financial results are subject to different variables than a manufacturer and distributor such as Altria and PM.
Nevertheless, Universal has maintained a very long history of dividend increases, as the company has maintained profitable even in a challenging industry. Profits declined in Universal’s fiscal 2020 due to lower sales and margin pressures but the company still generated adjusted EPS of $3.49, which allowed it to continue increasing its dividend.
The company is off to a better start to the current fiscal year. In the fiscal 2021 first quarter, Universal reported 6% year-over-year revenue growth thanks to higher volumes, offset partly by lower sales and leaf prices. However, operating income grew by 13% for the quarter.
Universal faces a slightly more uncertain outlook, as it is fully reliant on traditional tobacco products such as cigarettes and cigars. Whereas other tobacco companies like Altria and PM have diversified into other product areas, this will be much more difficult for Universal as it is not a manufacturer. Universal is attempting to diversify itself into adjacent agricultural categories, such as the 2019 acquisition of FruitSmart, independent specialty fruit and vegetable ingredient processor.
Universal is certainly aware of the direction that cigarettes and cigars are going, and as a result the company is taking steps to diversify itself as a broader agricultural products services platform. This will take time to materialize and there is no guarantee of success, meaning investors should consider Universal to be a higher-risk stock within the tobacco industry.