J#26 – Targeting High Dividend Yields in Tobacco Companies (Part 3)

This is the 3rd installment of our four-part journal series evaluating four tobacco stocks listed in Indonesia, Jamaica, Kenya and the Czech Republic.

In our last journal, given the volatility and the depreciating trend of the Jamaican dollar, we concluded that we would NOT be recommending investing in Carreras Ltd (a subsidiary of British American Tobacco). We have however continued referring to Carreras Ltd in this journal for the sake of comparison to the other three tobacco stocks and for academic reasons only. 

This journal evaluates the 5th question of our research – Do the dividend yields of these tobacco companies make them attractive investments?

But before we get down to the brass tacks, let’s also make things a bit more interesting by adding a fifth stock – Eastern Company.  It is listed on the Egyptian Exchange and has a market capitalization of USD 1.7 Billion.  This stock was identified by my business partner, Tim Staermose.  Let’s first apply the same analysis as we have done in journals J#24 (Smoking Rates & Excise Duties) and J#25 (Currency Risk) for Egypt and the Eastern Company.

SMOKING RATES, REVENUES & EXCISE DUTIES

Source: www.macrotrends.net

The conclusions we can reach are:

  • Year-on-year, from 2012 to 2016, Egypt has seen a growing consumption pattern in cigarette smoking (0.6% to 0.7% annual increases).
  • With the consistent increase in tobacco use, it’s clear that there was no material impact from the introduction of electronic cigarettes in Egypt.

A table of Eastern Company’s sales and excise duties paid from 2016 to 2019 is reproduced here.  There is NO trend to indicate a decline in cigarette consumption or a switch in government excise tax policies towards Egypt’s tobacco industry.

CURRENCY RISK:

There are no recent red-flags in the Egyptian Pound to the US Dollar warning us from investing in Egypt.

The major devaluation in late 2016 from USD/EGP 8.9 to 18.0 is a result of Egypt floating the Egyptian pound.  This is a positive structural change to how Egypt manages its currency.

A floating currency is subject to market forces rather than the currency being held stable or is manipulated by central bank intervention using their country’s foreign currency reserves.  A similar structural change occurred in Australia in 1983 and the United Kingdom in 1972. 

On the other hand, Turkey is in the process this very hour of paying the price of having a managed currency rate.  Their foreign currency reserves have dwindled to near zero.  They are at a crossroads and must look at following Australia, the UK and Egypt in floating the Turkish Lira to let free market forces reflect the rate of the Lira. Either that, or they will have to again significantly hike interest rates.  Turkey’s currency dilemma can be read about here.

Since mid-2017, the free-floating, market-driven Egyptian Pound currency rates have been relatively stable.  Moreover, there is a slight APPRECIATION versus the US dollar that would provide us with a tailwind should we decide to invest in Egypt and the Eastern Company in particular.

Dividend Yield Analysis & Potential Recommendations

Our mandate is to find investment gems that yield double-digits net of withholding taxes.  The yields on our five companies are:

TickerExchangeCompanyPriceDPS
per year
Dividend Yield
(Gross)
Withholding
Tax Rate
Dividend Yield
(Net)
TABAK.PRPrague
Stock Exchange
Philip Morris (Czech Division)13,5601,56011.5%See belowSee below
KE:BATNairobi
Securities Exchange
British American Tobacco Kenya PLC34233.509.8%15%8.3%
CARJamaica
Stock Exchange
Carreras Ltd6.490.649.9%33.3%6.6%
HMSP.JKJakarta
Stock Exchange
Philip Morris Indonesia (HM Sampoerna)1,415119.808.5%20%6.8%
EAST.CAEgyptian ExchangeEastern Company SAE11.971.4011.7%10%10.5%

Prices as at 01 November 2020

The dividend yield of Philip Morris (Czech Division) depends on your residency as summarized in the table below:

Investor ResidencyDividend Yield (GROSS)Witholding Tax RateDividend Yield
(NET)
Czech Republic resident11.5%15%9.8%
EU & EEA residents with the Czech Republic with an enforceable DTT or TIEA11.5%15%9.8%
Others11.5%35%7.5%

If you are a resident of the Czech Republic or reside in the EU or EEA (European Economic Area) with an enforceable Double Taxation Treaty (‘DTT’) or Tax Information Exchange Agreements (‘TIEA’) your NET yield would be 9.8%. 

Although a double-digit 11.5% gross yield is paid, as our Double Digit Dividends Fund is based in the British Virgin Islands it incurs a hefty 35% withholding tax.  This results in a NET yield of 7.5% and therefore would not make it a candidate for the Fund other than to act as a “fill-in” investment (see below).

Based solely on the analysis so far and the yields of the companies, we can conclude the following recommendations:

CompanyDividend Yield
(Net)
Potential Recommendation
(Subject To Further Analysis)
Philip Morris (Czech Division)9.8% for EU and EEA residentsPotential BUY recommendation for EU and EEA residents.
Potential "Fill-In" recommendation for the Fund - a WHT of 35% and a net yield of 7.5%.
British American Tobacco Kenya PLC8.3%Potential "Fill-In" Recommendation for the Fund.
Carreras Ltd (Jamaica)6.6%NOT a BUY Recommendation.
Currency Risk (see J#25) and too low a net dividend.
HM Sampoerna (Philip Morris Indonesia)6.8%NOT a BUY Recommendation.
Dividend too low.
Eastern Company SAE10.5%Potential BUY recommendation for the Fund.

As you can see, Philip Morris Indonesia’s (aka Sampoerna) dividends are a bit too low for us and so at this point, we are looking at the three remaining companies to invest in. However, 6.8% dividends is nothing to turn your nose up at, and so if any of my readers would like to consider adding it to their personal portfolio, I encourage you to research further if this stock fits your own investment mandate. As with Carreras Ltd, we will continue to refer to Sampoerna in this journal simply for the sake of comparison to the other three tobacco stocks and to walk through our investment selection processes. 

The dividend yields of Philip Morris (Czech Division), BAT Kenya and the Eastern Company have attractive dividends and are potential buys as a “fill-in” or outright “BUY” recommendations for our portfolio. I use the term “potential” as our analysis has not concluded.  We also need to ensure the following criteria are met by each company:

    1. A strong history of dividend payouts (measured by the company’s dividends per share).
    2. A history of high profit margins.
    3. Low leverage / debt levels (measured by a company’s debt-to-equity ratio).
    4. Significant insider ownership/holding.

A strong history of dividend payouts, low leverage and history of high gross profit margins are characteristics of capital efficient companies. They are attributes Porter Stansberry refers to (see our Journal # 24).  Specifically, they are companies that:

  • can grow sales without the need for additional capital expenditure (capex) to acquire, maintain, and upgrade existing physical assets, such as plant and equipment, that are used for manufacturing their product;
  • thus, return more capital to shareholders than they require for their annual capex requirements; and
  • also usually sell high-margin products in well-established and stable industries.

Before we look at leverage, gross profit margins and dividend histories of each of the five companies, I need to explain the concept of a “fill in recommendation.”

To ensure the Fund has a sustainable, high (above 10% pa) income, we cannot just sit on cash until we find the investment gem to allocate capital to it.  Investments such as tobacco stocks (and others) provide the necessary, to use my terminology, “fill-in investments.”  As we construct the portfolio, they help ensure that, overall, the fund maintains a double-digit return.  After all, we are interested in building a portfolio with a BLENDED, safe double-digit yield in this zero-interest bank deposits earning world we live in. 

  1. Dividend History:

Does the company have a solid dividend paying history?  With the exception of the Eastern Company, the answer for each of the other four companies, is a resounding “yes they do.” 

Dividend histories of the companies are provided in the tables below. 

The dividend history of the Eastern Company is clouded by two stock splits and two dividends that occurred in 2018.  This is discussed below together with the inaccuracies of 3rd party financial providers in disclosing the company’s current dividend yield.

Eastern Company (Egypt) – Stock Splits and Inaccurate Disclosure of Dividend Yields by 3rd party Financial Service Providers:

2018 to 2019 saw a large drop in Eastern Company’s dividends per share from Egyptian Pounds 11.00 to 1.00.  This is misleading as there were two stock splits in 2018 resulting in a larger number of shares allocated to each shareholder.  Announcements of the split can be read here and here.  There were also two dividends declared in 2018.  Each dividend was declared subsequent to each split.

A summary of these four 2018 corporate events (2 splits and 2 dividend payments) is summarized in the table below.

2018’s correct DPS on a blended basis after taking into account the stock splits and dividends is computed below.

A restated dividend history table for the last 3 years is produced below.

In the event, that we are to take a large investment in the Eastern Company, we would need to research into the drop in dividends from EGP 2.33 to EGP 1.43 per share.  

That said, at EGP 1.43 of dividends per share, that results in a net 10.5% yield at today’s stock price which is still a juicy return.

In addition to 2018’s corporate actions complicating our dividend history analysis, 2020’s dividends reported is also misreported by 3rd party sources such as Reuters.

Reproduced below are screen-shots of the Eastern Company’s yields published by investing.com and Reuters.  They state GROSS yields of 7.52%. Clearly this is incorrect. Our calculation of the Eastern Company’s dividend yield of 11.7% is reproduced below.  Incorrect published dividend yields are discussed in my Journal numbered J#19, “Rich Pickings! There are over 183 companies in our research universe of potential Double Digit Dividend investment gems.”

Stock splits aberrating dividend per share numbers and dividend yields incorrectly reported by 3rd party sources are some of the reasons why investment opportunities are undiscovered by the market and it provides us with opportunities that we can seize. 

Source: www.investing.com, as at 1 November 2020
Source: Reuters, as at 1 November 2020

The source for our calculation of Eastern Company’s dividend is directly from the company’s announcements.  It avoids the misinformation of 3rd party providers.  We got the following dividend per share calculation and yield.

Information Source:

  • Line Ref 1: Dividends Paid.  Note our table above uses information that was released by Zawya.com and is prior to Eastern Company’s announcement to the stock exchange.

Translation to English and subsequent publication produces timing issues.  We have used Zawya’s information as that was the only readily available English information at the time of our analysis.  Zawya’s publication can be found here.

Subsequent to Zawya’s publication, the Eastern Company made an English announcement to the Egyptian Stock Exchange.  This announcement can be found here.

There is little difference in our dividend per share calculation (1.40 Egyptian Pounds per share) to the 1.42 Egyptian Pounds dividends per share announced to the stock exchange.  The important lesson here is should we decide to invest in Egypt, we would require a broker in Egypt that can help us navigate announcement timing issues from translating Arabic announcements to English. 

2. Gross Profit Margins

Gross profit margin is defined as for each dollar of revenue earned; how much profits are generated.

GPM

In our margin calculations, our revenue numbers exclude government excise duty and taxes.  This results in the following margins for 2017 to 2019.

Gross Profit Margins201920182017
Philip Morris (Czech Division)51%43%50%
British American Tobacco Kenya PLC24%30%29%
Carreras Ltd (Jamaica)50%50%50%
HM Sampoerna (Philip Morris Indonesia)60%55%57%
Eastern Company SAE29%38%38%

All five companies have high gross profit margins and relatively consistent margins. In the event that we are to take a large investment in the Eastern Company, we would need to research further on the drop in margin from 38% to 29%.  Although a 29% margin is still a healthy return.

3. Leverage (Debt)

CompanyDebt /Equity
Philip Morris (Czech Division)*0.24
British American Tobacco Kenya PLC0
Carreras Ltd (Jamaica)0
HM Sampoerna (Philip Morris Indonesia)0
Eastern Company SAE0

*Excludes inter-company debt

Does the company have low leverage (debt levels)?  

The answer for the five companies we are analyzing is a resounding ”yes they do”.  Please refer to the table.

4. Insider Ownership

All five companies have significant insider ownership/holding ranging between 50% and 93%. Please refer to the table below.  The majority owners are the parent company (e.g. Philip Morris or British American Tobacco) who like to see the profits of their subsidiaries channeled back each year to them.  Our interest is therefore aligned with theirs. 

Company% of Direct OwnershipLargest Shareholder
Philip Morris (Czech Division)78%Philip Morris Holland Holdings B.V
British American Tobacco Kenya PLC60%Molensteegh Invest Bv.
(a Dutch subsidiary of BAT)
Carreras Ltd (Jamaica)50%Rothmans Holdings (Caricom) Limited
HM Sampoerna (Philip Morris Indonesia)93%PT Philip Morris Indonesia
Eastern Company SAE51%Chemical Industries
(Egyptian government-owned enterprise)

I have some concerns that Eastern Company’s major shareholder is a state-owned enterprise as  opposed to a well-known multinational parent, such as a Philip Morris and British American Tobacco.  Multinationals are able to bring their world-wide experience and management leadership to their local subsidiaries.  But so far, a review of the Eastern Company’s revenues and gross profit margins does not flag any poor business operations.

Further to our analysis of dividend history, gross profit margins and debt leverage and insider ownership analysis, our conclusions and recommendations remain the same.  That is:

CompanyDividend Yield
(Net)
Potential Recommendation
(Subject To Further Analysis)
Philip Morris (Czech Division)9.8% for EU and EEA residentsPotential BUY recommendation for EU and EEA residents.
Potential "Fill-In" recommendation for the Fund - a WHT of 35% and a net yield of 7.5%.
British American Tobacco Kenya PLC8.3%Potential "Fill-In" Recommendation for the Fund.
Carreras Ltd (Jamaica)6.6%NOT a BUY Recommendation.
Currency Risk (see J#25) and too low a net dividend.
HM Sampoerna (Philip Morris Indonesia)6.8%NOT a BUY Recommendation.
Dividend too low.
Eastern Company SAE10.5%Potential BUY recommendation for the Fund.

I hope that this and the two previous journals are informative and provides you with an insight into our stock selection processes.  The fourth and final part to this series of analyzing five tobacco stocks will cover the potential total returns we can expect to enjoy should we decide to invest in these stocks – and that’s in addition to their yields.

Yours, 

Peter