Certainly, the past two years have been very challenging for Carreras Ltd (CAR). Despite commanding 90 per cent of the local market for cigarettes, the Company’s sales volume has been threatened by a number of factors including a vibrant illicit market; considerable tax increases and now the impending public smoking ban. However, in the face of a difficult economy, Carreras’ core business regained momentum in its fiscal first quarter, reassuring shareholders of the Firm renowned for its superior dividend payouts.

Carreras’ dividend policy of paying out at least 65 per cent of earnings in dividends has made the stock extremely attractive to investors. In fiscal year 2010, the Company paid $3.4 billion or $7.00 per share in dividends. In fiscal year 2009, the Company paid out $7.9 billion or $16.30 per share, of which $4.03 billion ($8.30 per share) was attribut¬ed to a capital distribution from Cigarette Company of Jamaica Ltd (CCJ), a subsidiary in voluntary liquidation. While it is evident that paying out such a significant portion of earnings and/or existing cash reserves to shareholders limits the cash available for re-investment, this does not necessarily mean that the Company lacks the potential for future growth and development. It may signal management’s confidence in earnings growth and sufficient profitability to fund future expansion and the maintenance of the current and future dividends to shareholders.

Over the past decade, Carreras has managed to grow revenues from its core business almost two fold, with the only year-on-year decline seen in its financial year ended March 31, 2010 and to note, this was in line with most Companies on the Jamaica Stock Exchange (JSE). For the year, the distributor and marketer of cigarettes, generated Operating Revenue totalling $10.4 billion, marginally below the $10.9 billion it recorded in the previous year. This was mainly due to the Company experiencing a 27.5 per cent decline in volumes as increased taxation coupled with a softer economy resulted in lower sales. Over the past three years, the Government has increased the Special Consumption Tax (SCT) on cigarettes by 450 per cent per thousand cigarettes resulting in Carreras becoming an even larger contributor of revenues for the government.

As a result, Net Profit for the period declined by 26.7 per cent to $3 billion from $4.09 billion in fiscal year 2009. However, Carreras’s bottom line was more hurt by the fall-off in Other Operating Income coupled with a significant decline in Exchange Rate Gains rather than the decline in Revenues from its core business. During the period, Other Operating Income fell sharply by 65 per cent to $285 million from $821 million, mainly due to the reduction in Interest Income. This reflects the contraction of the Company’s investment portfolio as it continues to lower its cash balances through capital distributions and dividends coupled with lower interest earned on its investments.

In light of the challenging circumstances faced by the Firm, its management team took the decision to increase Marketing Spend last year in order to strengthen its brand portfolio capabilities to compete in a dynamic and ever-changing consumer and trade environment. Carreras achieved a turnaround in its first quarter, ended June 30, 2010 with a 30 per cent increase in net profit to $673 million or $1.39 per share. Revenue climbed to $2.97 billion compared with $1.88 billion a year earlier more than offsetting the fall-off in Other Operating Income, primarily interest income earnings. From an analyst standpoint, this displays the Company’s underlying strength and ability to produce growth in spite of challenges faced.

Many Firms on the JSE continue to feel the effects from their dependence on Investment Income, and have watched their profits decline as they try to find creative ways to increase earnings. Given that Carreras invests only in short term repurchase agreements, it was however better positioned and as such is among the Companies better able to weather the effects of the JDX.

The Firm has been able to continue to generate profits from its core business that are consistent with providing shareholders with an above average rate of return on their investments. Apart from having the highest dividend yield on the JSE, the Company is also the best performing stock year to date, with the stock price rising 46.15 per cent to $51.18. This means that Carreras has by far outperformed the JSE Main Index, which has seen a less than a one per cent gain year to date. In addition, the Company’s dividend yield of 9.8 per cent is attractive compared with the benchmark 180-day Treasury Bill, which yields 8.24 per cent.

It is widely anticipated that the Company will pay out a special dividend when it eventually recovers taxes from the Government of Jamaica (GOJ), following the Court of Appeal ruling in February this year. In late August, Carreras put in its claim to the Ministry of Finance for the $1.73 billion plus interest that has been accruing since 2007. It is expected that once this is recovered the Company would make a capital distribution to investors as it has done in the past. To put this into perspective, this would translate to $3.56 per share, excluding interest earned, in addition to the regular dividend payments one would normally receive from the Company’s profits.

Despite the strong stock performance since the start of the year, the outlook is positive for Carreras for the remainder of its fiscal year as the Company continues to display strength, with Revenues resurging as the core generator of income. For those investors who haven’t considered Carreras as part of their portfolios, the Cigarette Company is certainly worth a second look as it provides a “win win” opportunity – strong dividend yields above comparative GOJ local yields after-tax coupled with potential capital gains from a fundamentally sound Company.

Deirdre Witter is an Investment Analyst at Stocks & Securities Ltd. You can contact her at dwitter@sslinvest.com.