I am looking at four different tobacco stocks from Jamaica to Indonesia to determine whether they are a good fit as potential investments for double digit dividends. This journal is the first of a four-part series discussing what to look for when purchasing profitable dividend-paying investments.
After consulting with potential investors, colleagues, and advisers, I am encouraged to see that there is great interest in a Double-Digit-Dividend Fund, which would aim for a blended portfolio yield of over 10%, and pay out the distributions quarterly. I’m working earnestly on making it a reality. As part of that, I am obviously also doing the research on potential investments for the Fund to make.
All four of tobacco stocks I’m analysing have histories of more than a decade reliably paying out dividends to investors.
For the fund, some or all of these stocks–combined with other stocks, such as Jupiter Mines and Twiga Cement, which pay dividends in the low to mid-teens–may make a good fit, and would deliver a blended double-digit return on our money.
The potential universe of investments is broad and these journals are written to provide you with a flavour of our investment and thought processes.
Today, I want to give you a taste of these tobacco stocks and why we are looking at tobacco as an industry.
Gene Hoots put it aptly in his book, “Going Down Tobacco Road”, where he points out:
“Tobacco, for more than eleven decades, gave investors unbelievably good and consistent returns. One dollar invested in tobacco stocks in 1900 would have grown to $6.3 million in 2014, an annual compound return of 14.6 percent, beyond any other industry over that long period.”
Established players such as British American Tobacco, Japan Tobacco, Philip Morris International and Altria are able to achieve these long-term returns as they are capital efficient companies with wide “economic moats”.
What is a capital efficient company? Porter Stansberry in his article “The Single Best Way to Make a Fortune in the Markets” gives a good definition. His article can be read here.
Capital efficient companies, as Porter elaborates, are companies that:
The table reproduced here, from Stansberry’s article, lists the top 20 stocks in terms of returns by the S&P 500 in the 50 years between 1957 and 2007.
Surprise, surprise, who is on top of the list? Philip Morris, a tobacco company.
The list is likely to have changed with the recent focus on FAANG stocks, but nevertheless, what has been proven in the past remains: capital efficient companies, such as tobacco companies, make solid and consistent long-term investments. Moreover, for our purposes, since they don’t need to reinvest anywhere near all their profits, they tend to pay them out as generous dividends.
Tobacco companies also have a wide “economic moat”, a phrase popularized by Warren Buffet, who first learned of the concept from Phil Fisher. Businesses with a wide moat are those that are easily able to maintain competitive advantages over their competitors and new market entrants in order to protect their long-term profits and market share. They have strong balance sheets and operating margins where they can easily deploy their cash to develop new products and sell those products via established marketing and product delivery channels. In short, they are able to defend and grow their businesses.
There is a general perception by investors that the economic moat is shrinking in the tobacco industry due to the following threats:
In developed countries, government public health campaigns and increases in tobacco excise duty have seen a fall in smoking rates. But is this the case in developing countries?
Tobacco companies have strong cash balances and great distribution and marketing channels for their cigarettes. Are they able to use this to defend and grow their economic moat by manufacturing and selling e-cigarettes too? Have they been successful in their execution?
Let’s look at three of these developing countries, together with the Czech Republic. The Czech Republic is classified as a “developed” or “advanced” economy for a lack of a better term. I dislike the use of terminology that differentiates and categorises a country’s economy as “advanced” or “developing”. In my view, they are all developing and in some cases, an “advanced” economy may well be declining.
The countries and companies we shall look at are:
|Indonesia||Jakarta Stock Exchange||Philip Morris Indonesia |
|Kenya||Nairobi Stock Exchange||British America Tobacco Kenya||BAT.KE|
|Jamaica||Jamaica Stock Exchange||Carreras Ltd (subsidiary of |
British American Tobacco)
|Czech Republic||Prague Stock Exchange||Philip Morris (Czech Division)||TABAK.PR|
We’ll adopt a top-down approach to our analysis. Specifically, the questions we shall answer:
The charts below show the percentage of smokers in each country’s population as well as their year-on-year changes in smoking rates for 2012 to 2016. The data is from www.macrotrends.net who source their data from the World Bank. The data for 2016 is the last update available.
The conclusions we can reach are:
The World Bank data on smoking rates is only available up to 2016. For the period 2016 to date, our analysis uses revenue/sales results of the 4 companies mentioned above to evaluate tobacco demand. This data is reproduced in the charts below.
Year-on-year revenue numbers are published net of excise duties and value added taxes (‘VAT’). The trend of excise duties and VAT taxes as a percentage of revenues is a valuable indicator to signal to us whether there is a switch of government policy to taxing their respective tobacco industries more heavily.
The year-on-year revenue numbers of each of the four companies we are analyzing is also a valuable indicator to reflect whether their customer market share is adversely impacted by a switch of consumer tastes to e-cigarette products, and/or they have successfully defended their market share by various business initiatives including introducing e-cigarette products to their range of customer product offerings.
The conclusions we can reach are:
The “economic moat”, using Warren Buffet’s terminology, of these 4 companies remains wide.
Metrics such as gross margins, return on equity and invested capital are some of the measurements used to measure the width of the economic moats of these companies. These metrics, together with the dividend returns of these companies, are analysed in our four-part journal series.
Until next time, good investing.