Dividend Increase: Philip Morris (PM)

Philip Morris (PM) announced their 9th straight year of dividend increases this morning.  The new quarterly amount is being raised $0.02 to $1.04 per share for a mere 1.96% increase.  This is a disappointment.  My low expectation was a bump of $0.05 per share.  This is the second straight year of a below expectation increase.  Compare that  to my other tobacco holdings (MO and RAI) who have both exceeded my expectations on dividend increases the last 2 years.  However all is not bad news.  At least the share price has risen roughly 25% over the course of the last year, about in line with the performance of MO and RAI (tobacco has been smokin’ HOT).  Taking into account the new dividend, the yield on PM sits at 4.22%

So what’s behind the low dividend increase from PM, when both MO and RAI have generously increased their dividends?  Well, you have to look at the history of PM a little to understand what’s going on.  PM was spun off from MO back in 2008 (MO is a mastermind of spin offs and gets it right!)  Several reasons behind the spin off: hedge against lawsuits, hedge against different growth rates of tobacco consumption domestic vs foreign, and what is playing out for the last couple years-a hedge on exchange rates.  MO is the domestic provider of cigarettes.  PM the foreign provider.  MO’s profits are almost all $ denominated, so a strong $ for the last few years has been beneficial to them.  PM profits are denominated in foreign currency.  Converting those foreign currencies to a strong dollar = lower profit.  So taking out the currency fluctuations in PM earnings reports, things look good.  It’s just that strong dollar is really affecting the bottom line.  Because of the strong dollar, PM is more limited in their ability to currently boost their dividend further.

Let’s put it another way.  If you are a US citizen, now is a great time to travel abroad.  Those strong $ are going a long way in Europe and Asia.  However, Europeans and Asians visiting the US are having to fork over more money to travel here.  It won’t last forever though, as I believe things revert to the norm, so this is just a suck it up period as far as dividend growth is concerned for PM.  A suck it up moment?  Yes, if, when, and how fast the Fed increases interest rates (assuming the ECB and BOJ keep an easy money policy-which is highly likely), the US $ will actually get stronger.  Further denting earnings of PM and their ability to increase that dividend.  PM also has a really high payout ratio compared to its peers at 97%!

But wait, there’s more…

shamwow

It’s not just PM that would be affected as described above.  Think about the current global environment that large multinational companies operate.  Consumer staple companies like KO, PEP, MCD, PG, CL all generate a hefty amount of profits overseas (upwards of 40% of profits in some cases).  Same story.  Those profits in foreign currency convert back to fewer $.  Increasing interest rates will not help.  It’s not just limited to consumer staples.  Practically every large company you think of is affected by this threat of higher interest rates.  Even companies with no debt on the balance sheet.  That’s the reason behind my rant on my last post.  The Fed is playing a dangerous game with everyone who invests in “paper”.

End Second Rant.

Let’s get back to PM and look graphically at their dividend history:

So, although the last 2 years has been disappointing with regards to dividend growth.  Looking back at the last nine years, things are still looking good.  We have an average rate of growth on the dividend of 9.64%.  Throwing out the first year’s annual payout as an outlier (not a full year), your income almost doubles in the prior 8 years.  Or, if we work some backwards math and assumptions, assuming PM was public all of 2008, you would receive $1.92 in dividends.  Fast forward to 2016, and you are receiving $4.10.  In this case, the dividend income has more than doubled in 9 years.

As you can see in the charts, the last 2 years fall below the regression line.  Hopefully that reversion to the norm occurs in the next couple years.

How has PM performed vs the S&P500:

pm-vs-sp500

Fortunately, despite the last 2 years of slow dividend increases, PM has outperformed the S&P500 going back to 2008 when PM was spun off.

Let’s take it a step further.  How has PM performed compared to MO and RAI.

pm-vs-mo-vs-rai

Looking at a few of the major players in tobacco, we see that PM has underperformed compare to MO and RAI.  Ironically, the underperformance has largely occurred in the last 2 years.  See above about the strong dollar’s impact.  Yes, I’m long all 3.  Thankfully MO and RAI are much larger holdings.

Let’s look at some numbers behind PM:

Market Cap: $153 Billion

Dividend Yield: 4.22%

Payout Ratio: 97% (Yikes!)

Profit Margin: 24.99%

Total Cash: $3.81 Billion

Total Debt: $29.97 Billion

Levered Free Cash Flow: $5.31 Billion

No need to beat a dead horse.  Yes that high payout ratio concerns me and most of the problems arise from the strong $.  MO and RAI have payout ratios at 80%, high but expected in the tobacco industry.  Hopefully this interest rate cycle doesn’t drag out too long (whenever it starts).

So in closing, while I am disappointed with the dividend increase, I’m not selling.  Eventually things will revert back.  While dividend growth is muted, there is still hope for stock price appreciation.  If the global economies can’t really get organic growth, and things head south for GDP numbers, tobacco as least has a track record of holding up strong during recessions.  So maybe new money flocks towards tobacco to drive up prices.  I’ll still keep an expectation of a $0.05 increase to the dividend for 2017.

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