We already know that 97% of the companies in the FTSE 100 pay a dividend. It’s just that some companies are more generous than others.
Imperial Brands (LSE:IMB) is one of the UK’s largest businesses. It’s not necessarily a headline-grabber, but it’s massively profitable. And it has a 9% dividend yield, which puts it in the top 10 for the UK’s premier index.
The company trades on a low price-to-earnings (P/E) ratio of 5.9. The FTSE 100 average is 13. And normally, when a P/E ratio is that low, it doesn’t immediately say ‘bargain’ to me. More often, it means analysts have concerns about a company’s ability to grow.
However. A price-to-earnings growth (PEG) ratio of 0.4 tells us Imperial Brands shares are currently cheap. Any PEG ratio below 1 is considered good value.
Earnings are slated to grow 17.8% over the next 12 months.
Crush the competition
There has been some bad news for its FTSE 100 rival British American Tobacco recently. That company came out in early December to put a 30-year lifetime on some of its US brands. Effectively, this is the first time a tobacco company has acknowledged that its profit-making brands have a limited future.
For comparison, British American Tobacco says it will produce just 1.4% earnings growth next year. That gives it a PEG ratio of 4.4 (very expensive for this value metric).
Analyst RBC Capital Markets recently noted that Imperial Brands was the standout performer in the sector. Imperial Brands is “the only company in European tobacco to offer both dividend growth and share buybacks”, the December report said.
Buying back better
Since 2018, Imperial has bought back around 30 million shares. Over the same period, it has cut its debt from £11.2bn to £8.3bn.
The idea is that reducing the number of shares available should support the share price. A lower supply of shares, with the same demand? A higher price for each share can follow. Not always, but it’s a reasonable assumption.
Imperial’s ability to deliver on this promise — while at the same time improving dividend payouts — has helped it get a leg up on its rivals.
The stock is up 17% this year, compared to a 13% loss for British American Tobacco.
Look ahead
However, the outlook for tobacco companies in general is uncertain. These businesses will need to diversify away from traditional cigarettes. The growth markets here are in vaping and other nicotine delivery methods.
How quickly they can pivot to these new markets will be the real test of which survives.
And also, of course, how profitable those alternate products are will be key.
Imperial has been spending heavily on smoking alternatives, like oral and heated tobacco. Revenues in that side of the business have risen up 26.4% in the last 12 months, it has said.
And on the valuation issue, the risks should be fairly obvious. Will ESG concerns end tobacco company dominance? Possibly. But, as with fossil fuels, it could take many more years than investors suspect.
Imperial may not be a forever hold. But a 9% dividend, and a cheap PEG ratio are hard to ignore. Add in better performance than its rivals? It must be worth considering.
