Already yielding 8%, the Imperial Brands dividend forecast looks even better!

Our writer considers the Imperial Brands dividend forecast for coming years, and explains how it affects his decision whether to buy the shares.

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Tobacco shares can often offer high yields – and this one is no exception. Even after a dividend cut three years ago, the Lambert & Butler maker is still yielding 8%. But does the Imperial Brands (LSE: IMB) dividend forecast suggest another cut is on the way – or could the payout rise even further?

Uneven history

Understanding the background to that cut is helpful.

Imperial had been growing its dividend at a 10% clip annually for years. That made it popular with investors.

But business growth did not support continued increases at that level. The company had sizeable debt. It faced challenges that remain a risk today, especially a decline in the number of cigarette smokers in many markets.

Cutting the dividend, selling off the company’s premium cigars business, and reducing the annual rate of dividend increase (after the cut) to low single digits all helped to even the ship.

Last year the dividend grew 1.5%, and so far this year, the interim payouts showed the same year-on-year rise.

Long-term dividend affordability

The underlying challenges for the business remain, though.

Cigarette usage is falling in many markets. Imperial is trying to increase its market share in five key countries. But that is a tactic to buy time, not an underlying strategic fix, in my opinion. Meanwhile, competitors like British American Tobacco seem to be making much stronger headway than Imperial in building non-cigarette businesses.

Revenue at the firm actually fell slightly last year, while post-tax profits fell 43%. In the first half of this year, revenues grew minimally but earnings per share moved up 11.2% compared to the same period last year.

However, net debt also grew. At £10.3bn, it is around 65% of the company’s current market capitalisation.

Last year the dividend was covered only 1.2 times by earnings. Cash flow coverage was stronger, though. The company still had over half a billion pounds of free cash flow after spending £1.3bn on dividends to ordinary shareholders.

That means that, for now, an annual dividend increase of around 1.5% looks affordable. Indeed, that is the dividend forecast I am using for the next several years when considering the investment case for Imperial Brands.

The company says it has “a progressive dividend policy with dividend growing annually, taking into account underlying business performance”. But rather than boost the dividend more than 1.5% this year, it has been spending spare cash on share buybacks.

Tempting but not tempting enough

Over the medium term, the dividend forecast could look less compelling, however.

Yes, the dividend is covered, but business is barely growing if at all. Unless the company can eke out higher profit margins, that could make it harder to keep funding a growing dividend indefinitely.

The rise in net debt, adding to interest costs, is also a risk to profits.

So, while I expect the dividend to keep growing by a small amount annually for now, I prefer the portfolio and mid-single digits annual dividend growth of British American Tobacco, and can’t see myself buying shares of Imperial Brands any time soon.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

C Ruane has positions in British American Tobacco P.l.c. The Motley Fool UK has recommended British American Tobacco P.l.c. and Imperial Brands Plc. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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