J#25 – Currency Risk and Investing In Tobacco Companies as Dividend-Paying Investments (Part 2)

By nature of its cheap to produce but highly addictive product and the strong brand names owned by global industry leaders, such as Philip Morris and British American Tobacco , tobacco is an industry that consists of capital efficient companies (as discussed in Journal #24).  

We are adopting a top-down approach in our research.  The 4 tobacco stocks in our research universe, for now, are:

CountryStock ExchangeCompanyTicker
IndonesiaJakarta Stock ExchangePhilip Morris Indonesia
(HM Sampoerna)
HMSP.JK
KenyaNairobi Stock ExchangeBritish America Tobacco KenyaBAT.KE
JamaicaJamaica Stock ExchangeCarreras Ltd (subsidiary of
British American Tobacco)
CAR.XJAM
Czech RepublicPrague Stock ExchangePhilip Morris (Czech Division)TABAK.PR
Our research aims to address 6 questions listed below.  Questions 1 to 3 were addressed in the last journal and we concluded the following:
  1. Are the smoking rates materially declining in each of the above countries? No, they are not.
  2. Is there a switch in government policy to materially increase tobacco excise taxes (and thereby to potentially eat into the company’s profits)? There have been no material increases in government excise taxes.
  3. Does the company’s revenue numbers reflect an adverse impact due to consumers switching from smoking tobacco products to e-cigarettes? No adverse impacts were noted.
  4. Are foreign exchange rates, as a proxy for the country’s macro environment, conducive for us to invest there? (To be addressed in this journal)
  5. Are the dividend yields of these companies attractive enough for us? (Discussed in Part 3)
  6. What metrics can we use to measure capital efficiency and which of these companies are a
    great buy? (Discussed in Part 4)

We now turn to question 4 for our analysis.

We use a country’s foreign exchange rates as a proxy for assessing the country’s macro environment.  There is little logic in collecting dividends only for us to see those yields diminished by a depreciating currency in which we hold our investments.  For the tobacco stocks we are looking at, we pulled out A 10-year history of the foreign exchange rate (relative to the USD) for the Indonesian Rupiah (‘IDR’), Kenya Shilling (‘KES’), Jamaica Dollar (‘JMD’) and the Czech Republic Koruna (‘CZK’). These are reproduced below.

With the exception of Jamaica, the charts for Kenya, Indonesia and the Czech Republic (for the past 5 years or so) all have little volatility for us to be concerned about should we invest in these markets.  The spike (devaluation) in March 2020 of the Indonesian Rupiah was a reaction to the COVID-19 pandemic.  It has since appreciated back to its long-term (5-year) range of 13,000 to 14,500 to the US dollar. 

There are NO currency red flags in Indonesia, Kenya or the Czech Republic prohibiting us from investing in these countries.

In contrast, the Jamaican Dollar is a volatile currency.  It had a 17% swing from March 2019 (USD/JMD 125.1) to August 2020 (USD/JMD 150.2).  Coupled with the volatility is the worrisome trend that the Jamaican Dollar is DEPRECIATING against the greenback (USD).  It is near its all-time 10 year low. 

What’s causing the devaluation of the Jamaican Dollar?  The Gleaner (Jamaica’s daily newspaper founded in 1834) published a news article on 19 November 2019 which provides an insight:

“The unending devaluation of the Jamaican currency against the United States dollar is caused by one simple fact – Jamaica is managing two official currencies. The Jamaican dollar, by force and authority of the Government ….. (the) other official currency, the United States dollar, is the currency of choice, both as a store of value and a medium of exchange in transactions. Jamaicans will only exchange their coveted US dollar for the Jamaican dollar in a case of need.”

In short, Jamaicans have lost trust in their currency as a store of value and there is a parallel currency market in US dollars.

Our supervisory analyst/editor, Eunice, raises a good question – why don’t we buy the stock in USD?  After all, we get both the dividends, a capital efficient company (subject to our analysis in part 3 and 4 of this journal series) as well as the strong tail-winds of strengthening USD relative to the Jamaican Dollar.  Unfortunately, although the Jamaican stock exchange quotes Jamaican stocks in USD, Carreras Ltd is NOT one of their offerings listed in USD (please refer here).   

The Jamaican Dollar’s volatility and significant long-term loss of purchasing power means we would NOT recommend investing in Jamaica.

Carreras Ltd, by virtue of its base currency being Jamaican Dollars, is therefore NOT a recommendation we can make.  We will, however, in the next two journals continue to refer to Carreras Ltd in our comparisons to the other three tobacco stocks.  This is for comparison purposes only as these journals, amongst other things, aim to provide you with a sample of our research selection processes. 

Our next journal evaluates the 5th question of our research – “Do the dividend yields of these companies make them attractive investments?” 

Until my next journal, good investing.

Peter