If you are interested in growth-at-a-reasonable-price investing within the realm of large blue-chip stocks, you may have noticed that it is difficult to find a fairly valued dividend investment with:
- (1) A current 4%+ dividend yield
- (2) A reasonable likelihood of growing the dividend by around 10% annually for the next 5-10 years.
There is no rigid magic formula that tells you when a company's dividend is set to grow in the neighborhood of 10% annually over the future, but there are some character traits that can lend themselves to an impressive long-term dividend growth rate among large companies.
They are the following:
- (1) Company-wide growth of at least 7% annually, on average.
- (2) A meaningful buyback program that actually reduces the share count.
- (3) An entrenched status quo that has demonstrated a commitment to converting profits into dividends that reach the pocketbooks of owners.
I do not treat those as non-negotiable elements, but rather, as factors that shade into each other. Here is how they apply to Philip Morris International (PM).
In the case of the first element-you're getting your 7% growth from Philip Morris on a company-wide level, although it's not in a perfect linear style. Over the past five years, profits across the company have increased from $6.3 billion in 2009 to an estimated $9.5 billion by the end of this year (as an aside, I don't normally use estimates in my calculus, but as we near the end of the year, I grow more comfortable relying upon 2013 estimates in October 2013 than January 2013). That is annual growth between 8-9% annually.
But because of element number two-a declining share count fueled by a committed buyback program-the shareholder results become more impressive. That is because Philip Morris International has reduced the number of common shares outstanding from 1.887 billion in 2009 to 1.618 today. In 2009, Philip Morris was making $6.3 billion in profit that had to be split into 1.887 billion pieces. Now, the company is about to make $9.5 billion, which has to be split into 1.618 billion pieces. The earnings per share, which have grown from $3.24 in 2009 to shy of $6 at the end of 2013, explains why the company has had a compounded growth rate of 12.15% even though the company has only grown by 8.68% on an absolute basis (this is what happens when you blend organic profit growth with a real buyback program).
And that flows into element number three: the dividend per share growth. Philip Morris International paid $2.24 in dividends in 2009, and now they are paying out $3.76 per share. Since becoming a publicly traded company, the Board has given shareholders a raise every year. And the profit growth of 8.68% mixed with a declining share count (that allows you to become enriched at a 12% rate) gives the Board of Directors the kind of means to establish a long-term dividend growth rate of 10% if they feel so inclined.
So the question we have to answer is this: Is the current trajectory of Philip Morris International going to continue over the next five to ten years?
The short answer seems to be yes.
The longer answer is this:
(1) The Southeast Asia market seems likely to grow in excess of 20%. When you combine Central Europe, Eastern Europe, and Africa, you see that Philip Morris International is taking advantage of the "Wild, Wild West" laws-the returns on capital exceed 50%. There are only three likely risk factors that could prevent Philip Morris International from growing company-wide profits by at least 7% over the medium term: stagnation in Asia, and tougher-than-expected bans in the United Kingdom, and trouble with bans and sluggish sales in Russia.
(2) Most likely, that company-wide profit growth will continue to mix and mingle with a steady buyback program. The company is currently buying back $6 billion worth of stock. That's probably going to take another 60 million shares off the ownership rolls. This kind of sustained capital allocation decision is what turns 7-9% growth and turns into 11-13% earnings per share growth that allows the company to raise the dividend at a rate that exceeds "natural growth" because there are fewer shareholders to pay.
(3) Philip Morris International seems to be picking up that Altria (MO) gene in its DNA, and by that I mean a sound commitment to exceeding expectations and steadfastly raising the dividend. This company is ripe for 10% annual dividend growth. The Southeast Asia markets are actually experiencing volume growth (unlike the American markets, where tobacco companies pray for maintenance of the status quo rather than the ambition of true volume growth). The company is taking its sizable free cash flow and taking blocks of stock off the market. The company has a record of taking the growing profits per share and putting them in your pockets via regular dividend raises.
And then there's valuation. Right now, Philip Morris International is trading at over 16x earnings. I would classify 14-17x earnings as the range of fair valuation for a large-cap international tobacco company, based on present known risk factors. Usually, you pay fair value for something when you are satisfied with the potential growth rate, and think there is a high likelihood of that occurring. In the case of Philip Morris International, you get a company that is growing at over 7% on a company-wide basis, reducing the share count so that shareholders can experience a net effect of 11-12% growth, and a management team whose conduct makes it clear that dividend growth is a priority. That's why Philip Morris International seems set for 10% annual dividend growth going forward.