- Price increases offset volume declines
- Strong cash flow funds increased dividend and buyback scheme
- Forward dividend yield is around 8.5%, with buybacks on top
- Shares trade near twelve-month high
“Health campaigners and investors who run strict environmental, social and governance (ESG) screens may be frustrated by it, but income investors will be pleased to see shares in Imperial Brands trading near twelve-month highs after the company’s first-half results, which offer an increased dividend and progress in the latest share buyback programme,” says AJ Bell investment director Russ Mould. “Imperial’s global tobacco volumes fell by 6.3% year-on-year in the first half, even as the FTSE 100 member took share in three of its five target markets, but price increases of 8.6%, helped by a positive product mix, more than offset that to support the cash flow that pays the shareholder rewards.
“The shares’ fat dividend yield and lowly valuation – the forward dividend yield of 7.9% is fraction higher than the forward price/earnings ratio of 7.8 times, according to consensus estimates – still suggest that investors remain concerned about the long-term future of smoking, thanks to how regulatory pressure and health campaigns continue to weigh on volumes. But Imperial Brands remains highly profitable and cash generative thanks to efficiency drives and pricing power.
“That pricing power comes from the FTSE 100 firm’s array of key brands, which includes JPS, Davidoff and Gauloises, despite regulatory intervention on issues such as packaging and advertising.
“Pricing power is always valuable, but it is all the more so when inflation is running strongly and firms face margin pressure from rising input costs. Pricing power protects lofty profit margins, lofty profit margins support cash flow and cash flow funds dividends.
Source: Company accounts, Marketscreener, Vuma, consensus analysts' estimates
“The dividend cut of 2020 is now fading from memory, as Imperial increases its first-half dividend by 4% and runs its £1.1 billion buyback.
“Add the forecast dividend and the buyback together and Imperial is set to return the equivalent of nearly 15% of its market cap to shareholders in cash.
Source: Company accounts, Marketscreener, Vuma, consensus analysts' estimates
“Again, this is possible because of strong cash flow, which comfortably covers the dividend. It even – just – covered the dividend in 2019 before the swingeing cut, but chief executive Stefan Bomhard wisely took the view that long-term investment in the business was a better option than clinging to the millstone of an extremely high yield, for which the firm was getting no credit from investors anyway, judging by how the share price was sliding back then.
“Admittedly, free cash flow was not strong in the first half of fiscal 2024, thanks to a big working capital outflow, but this may well normalise in the second half of the year.
Source: Company accounts
“The long-term reduction in net debt came to a halt in the year to September 2023, thanks to increased inventory, higher capex and – above all – last year’s £1 billion buyback. The working capital outflow, higher dividend and new buyback means debt is up again in 2024 but earnings cover for the interest bills remains healthy. In the first half, operating profit of £1.5 billion generously covered net interest costs of £354 million.
Source: Company accounts
“This is the fourth year of chief executive Mr Bomhard’s five-year turnaround plan, and Imperial Brands is nevertheless having to work hard. The group’s medium-term plan is to grow sales and operating profit at a mid-single digit percentage rate, on a constant currency basis. However, in fiscal 2024 Mr Bomhard expects low single-digit percentage sales growth with a mid-single digit percentage profit increase, although the earnings advance is second half weighted.
“Currency movements remain a headwind but lower losses from next-generation products (NGPs) should help, although investors are clearly yet to be totally convinced that Imperial Brands can weather the regulatory storm, where a new round of legislation in the UK is just one example of the ongoing pushback against smoking.
“Investors are demanding the high yield (with the buyback cash on top) to compensate themselves for the perceived risks involved.
“The earnings multiple is a discount to the FTSE 100 and the yield a premium. That at least partly reflects the modest growth trend in profits, regulatory threats, including in the UK, and the need to invest in next generation products (NGPs) such as blu, Pulze and iD, where sales rose by a sixth year-on-year in the first half.”
