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Stock of the Week: Imperial Brands

·3-min read
Post-It Note
Post-It Note

For the latest stock of the week we asked our Twitter followers which high-yielding FTSE 100 stock we should write about and they have chosen tobacco firm Imperial Brands (IMB) above other dividend stalwarts like BP, Legal & General and Vodafone.

Imperial Brands is one of only three UK companies covered by Morningstar that has both a wide economic moat and a five-star rating, which means that its shares are significantly undervalued. Analyst Philip Gorham assigns a £34 fair value estimate to the company’s shares, more than double the current price around £13.

The company has been traditionally sought after for its defensive qualities and reliable dividends payouts. But in May the company announced a dividend cut, following many FTSE companies down that path, as part of first-half financial results for the year ended March 31, 2020. It declared a dividend of 41.7p per share, a 33% fall from the 62.56p paid to shareholders in the same period last year. The company said that this cut was part of further attempts to reduce debt and that it is maintaining its progressive dividend policy – essentially the payouts rise and fall depending on how well the company does, rather than the previous commitment to a fixed dividend. This change was decided in 2019, so the company had already taken steps to adjust its dividend policy before coronavirus caused chaos in the UK equity income space.

Despite the dividend cut, Imperial yields over 13%, one of the highest in the FTSE 100, as the share price has maintained a downturn trend this year despite a minor recovery from the March market collapse.

Smokers Are Good Customers

Morningstar analysts think that Imperial has a wide economic moat, or sustainable competitive advantage, because smokers are loyal to its brands, the largest manufacturers benefit from economies of scale and tight regulation in the industry keeps competitors at bay and market shares stable. The nature of the product itself creates loyalty, Gorham says – “a majority of smokers attempting to quit fail to do so”, especially in premium segments where Imperial operates.

While the tobacco industry is usually thought of as recession-proof, it has gone through something of an existential crisis in recent years and that partly explains Imperial’s share price slide from £35 five years ago to £13 today. What the companies call “next-generation products” such as vaping were supposed to help firms (and smokers) manage the transition away from traditional cigarettes. But a crackdown on vaping in the US has stalled expected growth in this area.

Morningstar’s Gorham says that “government intervention is an omnipresent threat” in the industry and investors have to be prepared for a rough ride in share price terms. In its latest trading update on October 8, Imperial said it expected next-generation revenue to be down 30% this year, while tobacco revenue is expected to rise 1%. The pandemic, while boosting cigarette sales generally (people in lockdown have been smoking more), has hit duty free sales because of the collapse in international air travel.

Among Morningstar-rated funds, Imperial makes up over 6% of the Silver-rated M&G Global Dividend Fund and over 4% of the Jupiter Income Trust, which also has a Morningstar Analyst Rating of Silver.