by Louis Basenese, Advisory Panelist

Last week, I provided my six-step strategy to avoid the dividend investing trap and find stable, high-yield dividends. Today, the rubber hits the road…

If you’re looking for a dividend paying stock to bolster your income – one ideally suited to weather the current economic mess – look no further than Philip Morris International, Inc. (NYSE: PM).

10 Reasons This Dividend Won’t Go Up in Smoke

When it comes to evaluating the safety of a dividend paying stock, the first thing we need to verify – given the current economic slowdown – is demand for a company’s products. After all, a company needs a steady stream of cash coming in to afford to pay it out to shareholders. So, the first three reasons, understandably, pertain to Philip Morris’ rock-solid demand…

1. Recessions don’t matter. As you might suspect, addictive products tend to enjoy the steadiest demand. In fact, based on empirical evidence out of Citi Investment Research, the last two recessions “had no material effect on [cigarette] demand.” This go round should be no different.

2. Higher taxes are offset by population growth. As world governments contend with sagging economies, they continue to turn to tax increases on cigarettes to meet budget obligations. And obviously demand is not inelastic – consumers are sensitive to price changes. The World Health Organization estimates for every 10% increase in price, demand slips 4% in mature markets and 8% in developing markets. However, when you factor in population growth, the impact is almost cut in half. More importantly for Philip Morris, its highest margin markets (accounting for 60% of revenues) come from the less impacted mature markets. In other words, the company’s profits are extremely durable.

3. Emerging markets. The WHO estimates that 80% of the world’s 1.3 billion smokers live in developing countries. Sales in emerging markets are increasing modestly compared to declining volumes in developed markets. Philip Morris is uniquely positioned to capture the lion’s share of this growth. It owns seven of the leading 15 international brands Incorporatedluding the hands down leader, Marlboro. It operates in 160 countries and already derives over 60% of sales from emerging markets. So it’s no surprise that total volumes increased a steady 2.5% in 2008. And total sales, net of excise taxes Incorporatedreased by 12.7% to $25.7 billion. As management acknowledges, there’s no mistaking that, “This strong performance was driven by emerging markets.”

Show Me the Money… to Pay the Dividend

Beyond steady demand, we also need to verify that cash isn’t being misspent and jeopardizing the stock dividend payment. The next three reasons pertain to Philip Morris’ ability to pay its dividend indefinitely…

4. Ample free cash flow. In 2008, the company generated $6.8 billion in free cash flow, a year-over-year increase of 52.7% thanks to solid sales growth, supply-chain optimization and other cost-cutting initiatives. Best of all, this figure should keep climbing, as the company is only about halfway through its three-year, $1.5 billion cost-reduction program.

5. Solid cash buffer. With $2.4 billion in the bank, Philip Morris is sitting on enough cash to cover two quarters worth of dividends.

6. Minimal litigation and regulation risk. The 2008 spin-off from Altria eliminated the legal and regulatory risks facing the domestic operations. In other words, we don’t have to worry about the possibility of any adverse judgments requiring the company to pay enormous settlements, thereby hindering its ability to pay the dividend in the short to intermediate term. Same goes for the newly passed legislation granting the FDA regulatory control over the industry.

7. Credit is no concern. The bulk of the company’s debt was issued before the credit markets soured. And it’s well laddered at “attractive interest rates,” so there’s no concern about interest costs skyrocketing and cutting into dividend payments due to untimely refinancing. Should any emergencies arise, the company can tap into its $6 billion in unused bank credit lines.

8. The payout ratio is conservative. Even after increasing the dividend by 17.4% in August, to $0.54 per quarter, the company’s still only paying out 61% of profits. So profits would need to drop dramatically to pose an immediate threat to the current payout. The low ratio also leaves plenty of room to increase the dividend.

A Good Measure of Subjective Value, Too

The final two reasons the company’s dividend is safe pertain to subjective factors, like management and market predictions. As a result, they’re not significant on a standalone basis. But they do contribute positively to the overall outlook for the stock…

9. Management pedigree and commitment. Remember, Philip Morris spun-off from Altria, which increased its dividend in 39 out of the last 41 years. That history and “commitment to reward our shareholders generously” is ingrained in Philip Morris’ management. And as the CFO reveals, if maintaining that commitment “means that the payout ratio overshoots 65% [occasionally], so be it.”

10. Currency tailwinds. A strong dollar hurts results because the company is based in the United States, yet records almost all of its sales in foreign markets. However, many experts (and yours truly) believe the dollar is doomed, which will only magnify the company’s profitability.

In the end, the fundamentals above prove the most important thing as an income investor – the dividend’s safe.

They also point to the prospects for steady share appreciation. After all, the stock’s trading cheaply, at just 12 times earnings and management expects to increase earnings by 14% next year.

As CFO Hermann Waldemer explains, “We have excellent momentum going into 2009. Our market shares are growing overall… And our share growth is accelerating [too].”

We’ll get proof when the company reports earnings July 23. But if we wait for the results, I’m afraid shares will get away from us and diminish the yield.

At current prices, the stock pays a reliable 5% with strong prospects for prospects for appreciation. So don’t miss out.

Good investing,

Louis Basenese

View original at: Investment Advice and Investment Research with a Contrarian Point of View

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