4.27% Dividend Champion Is More Than A Dividend Champion

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About: Philip Morris International Inc. (PM), Includes: WMT
by: Colorado Wealth Management Fund
Summary

Philip Morris’s future looks bright with the weakening of the dollar.

The dollar index is in a downward trend.

A weakening of the dollar should improve PM’s earnings and dividend growth.

Philip Morris (PM) is more than a dividend champion. It is more than an international tobacco behemoth. It is more than a solid investment. Philip Morris is also a hedge against inflation.

Philip Morris is selling all of their products internationally. Their revenue is denominated in foreign currencies. I wrote about the strong dollar on 10/24/2017:

Philip Morris has been absolutely hammered by the impact of changes in the exchange rate. The growth in the strength of the dollar is a real factor for PM. This factor continues to hold the company back. On the plus side, ex-currency metrics for the company have been strong which means they are not inherently flawed. The challenge from a stronger dollar is more than an impact on the accounting statements. Philip Morris must have more foreign currency to exchange for the dollars they use to pay shareholders their dividends.

Dollar index:

Since 2014, the dollar index climbed substantially. It reached a peak in early 2017. Since then, it declined dramatically which provides some relief to Philip Morris. Overall, the dollar index is still significantly higher than it was at the start of 2014. For Philip Morris, a lower dollar index is generally better.

Philip Morris is creating a hedge against inflation. If inflation in the United States happened to actually take off (hasn’t happened yet), it suggests the dollar index would be in a rapid decline. If the dollar index remains high, inflationary pressures are mitigated by lower costs on foreign goods. Though, to be fair, a significant chunk of those savings would be captured by sellers of the products – not passed on to the consumers. Ironically, macroeconomics still assumes these savings will pass to consumers immediately. In perfect competition that may happen, but in oligopolies that isn’t the case. If I can guess where you shop for groceries in only a couple tries, it’s probably not perfect competition.

A weaker dollar (low dollar index) makes imports more expensive. Inflation increases with a weaker dollar. If we have a weaker dollar, it would be positive for Philip Morris. They would have stronger earnings and be able to pay larger dividends.

Dollar index today

Jump to today, and the dollar index is moving towards PM’s favor:

Source: Bloomberg

Current environment

The recent weakness of the dollar is very attractive for Philip Morris. It should allow them to improve their earnings cash flow and dividends. The impact of a weaker dollar is quite significant for their earnings.

Investors focusing on dividend income will often be concerned about future inflation rates. They want their dividends to grow faster than the rate of inflation. There are a few potential factors that can drive inflation. The most prominent factors are broken down to either the cost of services or the cost of products. We are investors, but we are also human. We invest to create the wealth that will cover our expenses. When inflation is high, it will involve either higher expenses for services or higher expenses for products. Of course, it could involve both.

If we see a material increase in the price of products, one major factor would be the weak dollar. A substantial amount of the physical things we consume are produced in foreign countries. The workers are paid wages in foreign currencies and the landlords may be paid rent in foreign currencies. When the dollar is weaker, it will gradually lead to higher inflation. The impact appears to be immediate in economic text books. In practice, it is not immediate. Investors can verify this by reviewing Walmart’s (WMT) discussions with suppliers. When the dollar strengthened dramatically, they were stuck attempting to negotiate with suppliers in China on prices that were listed in dollars.

This is the area where Philip Morris shines. If inflation comes from a weak dollar, the earnings for PM should be growing significantly. Since Philip Morris uses most of their adjusted earnings for dividends, it would be reasonable to expect dividend growth to improve if the dollar remains weaker.

Inflation in services

There is a second kind of inflation where Philip Morris is less effective. Inflation in the cost of services is not as simple as a weak dollar. The inflation in cost for services will generally reflect factors such as higher rent or higher wages. There are two kinds of rents that will impact the investor. If the investor is living in a rental house or apartment, their rental expense is easy to identify. If they are living in a property they own, they will could see higher costs throughout the economy if the landlords of the businesses are able to raise rents.

Investors can protect themselves to some degree by owning positions in the relevant landlords. For instance, if the investor is renting an apartment, it would make sense for their portfolio to be overweight in apartment REITs. If apartment rents are rising dramatically for a prolonged period, the apartment REITs will see a substantial increase in revenue which will lead to an increase in net operating income which leads to an increase in FFO and finally in dividends. The chain has several steps on the income statement, but it happens rather quickly. Those factors beyond dividends should all increase immediately while prudent management would look to raise the dividend a couple months later.

What this all means

Investors have a solid opportunity. Philip Morris is trading at an attractive valuation again. The weakness of the dollar should be a tailwind for future earnings. In addition to the solid dividend yield from Philip Morris, it has the benefit of strengthening when the dollar weakens. That gives investors another layer of protection against rising prices on imported products. To round out the portfolio, it would be wise to also look for an allocation to REITs. The REITs will assist in protecting the portfolio from increasing costs for services. By owning a position in the landlord, the investor is protecting themselves against increasing costs for property rentals. Investors would still be exposed to inflation from wage growth. Apartment REITs serve as a useful hedge there as well. Wage growth correlates very strongly with growth in rental rates. The only thing investors wouldn’t be protected from is a dramatic surge in Treasury rates.

Disclosure: I am/we are long PM, WMT. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: No financial advice. Investors are expected to do their own due diligence and consult with a professional who knows their objectives and constraints. CWMF actively trades in preferred shares and may buy or sell anything in the sector without prior notice. Tipranks: Buy PM.