3 Tobacco Stocks Lighting Up Dividend Payouts

These stocks have sustainable dividend models you can count on

   

Inspired by the inflation chart going back to 1872, which I showed in last week’s MarketMail, I searched for a longer-term perspective on the stock market’s dividend yield, as represented by the S&P 500 or its equivalent. As luck would have it, Global Financial Data posted a chart of the 10-year constant maturity Treasury yield going back to 1870 vs. a chart of the S&P 500 dividend yield over the same time period.

Since the S&P 500 has only existed in its current form since 1957, I am sure the folks at Global Financial Data are using a NYSE average of sorts (the first stock index was the Dow Jones Industrial Average, dating back to 1896, with a predecessor developed by Charles Dow in 1884). Global Financial Data had previously done some interesting comminglings of various sources to get the longest possible history on record, so I will give them the benefit of the doubt that this stock market/10-year yield is close to par.

The blue line is the 10-year bond constant maturity yield, and the red line is the S&P 500 dividend yield.

MM Chart1 3 Tobacco Stocks Lighting Up Dividend Payouts

Source: Global Financial Data

Note that the above chart was posted on GFD’s website in February of 2013. There has been quite a bit of drama in the bond market since last February, but even with the 2013 QE tapering drama, the back-up in yields is still within the long-term downtrend that started in 1981.

Is QE “Working,” or is it Merely Delaying the Inevitable “Deleveraging” Process?

I will not be convinced that this bull market in bonds is over until the Fed delivers successful tapering and a successful unwinding of QE. This is because the tapering itself may cause the bond market to overshoot, which may cause all sorts of issues in a slowly de-leveraging – but still highly-leveraged – economy.

MM Chart2 3 Tobacco Stocks Lighting Up Dividend Payouts

If you want to zoom in on a shorter 30-year time frame, the 10-year yield had what technicians call a “false breakout” in 2007, due to an inflation scare which turned into a horrific deflation scare in 2008.*

So, in the short term, the 10-year note chart is shooting up. This suggests, from a tactical perspective, that it would be difficult to fight the bearish trend in government bonds. Still, if you look at the situation more strategically, I think we are due for another deflation scare in 2014 that may extend into 2015 due to the inability of departing Fed chairman Ben Bernanke to get the U.S. economy to re-leverage with QE.

What I mean by that is that the total leverage in the economy is falling again. Falling total leverage and sharply rising interest rates do not go hand in hand. A QE tapering mistake can slow down the economy so much that we may see 10-year Treasury note yields revisiting their 1.39% low from 2012.

I have publicly stated – and will repeat here – that if the 10-year Treasury note falls below 1.39%, it would mean the complete failure of QE policy, as the move would most likely be driven by deflation, which is exactly what QE has tried to prevent. For the time being, therefore, QE is neither a success nor a failure, but an elaborate maneuver to buy time for something else, which has yet to become apparent.

Why Sustainable Dividends Matter So Much Right Now

Dow Chemical (DOW) and LyondellBasell Industries (LYO), discussed previously here, are examples of highly cyclical businesses paying high dividends. In this environment, where we might get a whiff of deflation, you might want to be invested in less cyclical dividend payers, as deflation tends to weaken corporate revenues and ultimately endangers the payment of high dividends.

Over the past five years, the highest annualized dividend growth belongs to CMS Energy (CMS), Lorillard (LO), and L Brands (LTD). In fact, L Brands is in the top three spots in the three-, five- and ten-year annualized dividend growth rate tables due to the payment of large semi-annual special dividends (skipped in 2013 because of the larger amounts paid in 2012 due to better tax treatment).

While I have discussed L Brands before, CMS Energy puzzled me as utilities are supposed to be steady high-dividend payers. CMS has a very respectable but not exorbitantly high dividend yield of 3.9%. So how come the 36.2% growth? In 2002 and 2003, CMS saw its quarterly dividend yield cut from 36.5 cents to 5-cents in two swift moves. The fascinating saga of energy trading companies – culminating with Enron’s collapse – had extensive repercussions with CMS Energy, described in more detail here. CMS is a different company now. It has stood by its word to restore its dividend, as business conditions allow.

This leaves us with Lorillard (LO), the third largest U.S. cigarette maker. Discussing Lorillard would be incomplete without including Altria Group (MO) and Reynolds American (RAI), the top three enablers of the ever-shrinking U.S. cigarette market. This chart shows the decline in cigarette smoking rates, but the data is incomplete, since the percentage of cigarette smokers has declined from 20% to 18% in 2013.

MM PercentageSmokers 3 Tobacco Stocks Lighting Up Dividend Payouts

All three cigarette stocks have either spun off or divested their international operations—which are very vibrant and rapidly growing at the moment—and all three are leveraged towards the shrinking U.S. cigarette market. The question becomes: How does one invest against a headwind of fewer U.S. smokers?

The dividend growth of all three—LO, MO, and RAI—is impressive in the present environment. They are determined to give out every last penny as dividends and adapt to the new market conditions as they develop. A decline to a zero-percent smoker rate within 10 years sounds like a chimera, but constant price hikes and continual cost-cutting have made the three top tobacco processors some of the best dividend dynamos on Wall Street. I do not believe that there is any reason to fear dividend cuts for some time as tobacco dividends fill the sustainability bill to a “T,” even as the number of U.S. smokers declines.

*If you want to know my opinion on technical analysis, I use charts to study the major trends, but I have never been comfortable enough with technical analysis to make an investment decision based solely on a chart. I have to know what is behind the chart and how to interpret the numbers that the chart reflects about the asset in question.

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Article printed from InvestorPlace Media, http://investorplace.com/2013/12/dividends-still-rather-low-historical-standards/.

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