Looks like I have a little capital from my recent ARCP sale to deploy, so I wanted to take this opportunity to research a potential investment for the excess capital. For me, it was a no-brainer figuring out which stock I was going to analyze. Tobacco has a relatively low weight in my portfolio even though the power companies in the industry offer a very attractive yields. With stock prices falling lately, it seemed like a great time to assess my only tobacco holding, Philip Morris (“PM”), to determine if I should re-up my position.
Who is Philip Morris?
PM is an international cigarette company, with the three largest revenue regions consisting of Europe, Asia and Middle East/Africa. PM’s brand portfolio consists of some pretty big names in the industry, holding brands such as Marlboro, Parliament, L&M, and of course, Philip Morris. In 2008, PM was spun-off from Altria Group (MO), which decided to separate its international and domestic business operations. Now, PM sports the largest market cap in the cigarette industry, sporting a market cap of over 128.1M. The next closest companies are MO, ~$108b, and BTI, ~$104.1b.
Share Repurchase Program
Even though we focus on dividends in this blog, another great way for a company to provide shareholder value is to repurchase some of their current outstanding stock. As we discussed at length in a post a few months ago, a company can use share buyback programs as a means to reduce their share count, increase their EPS, and lower their payout ratio. Thus, buyback programs can provide room for companies to continue to grow their dividend for years to come. For PM, in 2012, the company announced a share repurchase program committing $18b to repurchase shares over three years. Through the 4th Quarter of 2014, PM has spent $12.6 billion to repurchase shares based on their recent earnings release, meaning the company still has $5.4b worth of shares to repurchase under the program. However, during their most recent earnings release, management stated that due to market pressures, the company will not repurchase any additional shares during 2015. This is unfortunate, especially considering how beneficial stock repurchase programs can be for dividend investors, because $5.4b in shares to repurchase this year, which could potentially repurchase ~65.5m shares, increasing EPS from $4.76 to ~$5.19, and lowering the payout ratio to 77%. If the pressures turn out to be short-term in nature and the market conditions improve, management can always decide to repurchase shares under their current program (which they emphasized in the release). Hopefully that is the case and us shareholders will get a boost later on in the year.
Dividend Diplomats’ Stock Screener
- P/E Ratio– Our first test is to assess whether the PE Ratios are less than the S&P 500 ratios. For our analysis, we will use the forward PE ratios, which are based on an average estimated earnings for the year. Currently, the S&P 500’s forward PE ratios is ~17. Based on the table below, BTI is the only one of the three companies to have a forward PE less than the S&P. This is very interesting as I was expecting PM to have the lowest of the group.
- Payout Ratio– As a part of our analysis, we typically focus on companies with payout ratios less than 60% as we believe 60% provides a solid safety net in the event the company’s short-term earnings are impaired. This is a rough number as we have been known to purchase a stock with a payout over 60% before; however, it takes a whole lot of convincing in that scenario and the company better be strong in other areas. Based on our analysis (using forward earnings consistent with the PE Ratio comparison), all three of the companies have payout ratios greater than our threshold. Wow! I was not expecting that. I knew tobacco companies had higher payout ratios to support higher dividend yields, but I wasn’t expecting all three companies to have payout ratios exceeding 60%.
- Increasing Dividends– We love increasing dividends. Why? Because we want our income streams to increase at a rate greater than inflation so we do not lose purchasing power with our funds. We calculated the one year and three-year dividend growth rates for each of the companies in the table below. PM has the largest average dividend increase over the last three years, averaging an increase of 9.12% while BTI had the highest dividend increase last year, increasing their dividend 11.42%. Overall, very strong growth rates for all three companies as they increased their dividend well over the inflation rate. These growth rates are much higher than I was expecting from the companies considering their current dividend yields, as I typically expect high dividend yielding stocks to grow at a lessor rate than low dividend yielding companies. One last item about the growth rate, all three stocks have dividend growth rates greater than my portfolio’s current weighted average. Which is a major plus considering that all three of the companies would increase my dividend yield and my portfolio’s weighted average growth rate. Fantastic news! One of my goals for the current year was to try and only add companies to my portfolio that would increase either (or both) my portfolio’s current dividend yields and/or my weighted average growth rate. I know that is not always possible, but luckily, all three of the tobacco companies would fit this bill! To see why I am so excited about this, read why your portfolio’s weighted average dividend rate is an important metric for your portfolio.
- 5 Year Average Yield- Lastly, in 2014, Lanny wrote a great article discussing why he reviews a company’s five-year average dividend yield. For this, I will only review PM’s average yield since it is the featured stock in this article. Over the last five years, PM has averaged a dividend yield of 4.17%, which is much lower than the company’s current yield of 4.85%. This could indicate two things: the dividend is too high and could be potentially cut or the stock is under valued and is set to appreciate. Considering PM recently announced their dividend increase, I am going to assume the latter scenario is more likely than the former.
I am a little surprised by the results of the analysis, considering I was expecting PM to perform well in our screener. However, based on the results of the screener, PM does not pass our screener as the company failed both the PE Ratio and payout ratio screens. The bigger question is should I consider purchasing BTI over PM? After all BTI would provide me with the same international tobacco exposure as PM and the company performed better in our stock screener. Regardless, since neither PM, BTI, or MO passed all three metrics of our stock screener, I will not be purchasing their shares with my excess capital. Going forward, I will add PM and BTI to my watch list to see if the stocks depreciate and become a greater value.
What are your thoughts on the analysis? Have you purchased shares in PM, BTI, or MO recently? If so, why did you select one company over the other? Would you consider purchasing one of the stocks even though they have a high payout ratio? Please let me know your feedback of this analysis!