Is Imperial Brands a stock worth buying for passive income, or is there a catch?

Imperial Brands looks cheap and the dividend is high, but is it one of the best stocks for passive income, or is it risky?

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Collecting passive income from stocks and shares is straightforward.

Public listed companies often allocate part of their profits to shareholder dividends. And the better businesses have been reliable payers for years.

However, even steady dividend stocks can come with a catch. And one such example is smoking products provider Imperial Brands (LSE: IMB).

A declining valuation

The problem for investors is the disappointing medium-term performance of the share price since 2016.

An investment made around that time would have been a poor one despite the stream of passive income from dividends. 

However, the financial and trading performance of the business has been steady while that long downtrend played out. Therefore, the main reason for the decline has been a savage valuation down-rating.

With the share price near 1,780p, Imperial Brands appears cheap now. The forward-looking dividend yield for the trading year to September 2024 is above 8%. And the anticipated earnings multiple for that year is just below six.

The company may make a decent long-term dividend investment from where it is now. But there are some headwinds and risks for the business to navigate in the coming years.

For example, the smoking industry is in long-term decline. In the recent full-year results report, chief executive Stefan Bomhard said the company has “offset structural volume declines with strong pricing in all key markets”.

To me, that sounds like a shorter-term solution to bolster earnings. Selling prices can’t keep rising forever beyond the rate of inflation. It seems likely that sales volumes may decline further if prices become too high for customers to afford. 

Buybacks and dividends

However, the company has also been gaining market share with its cigarettes. Over the long term, such gains in an overall declining market are a bit like running up the down escalator. But the advances are important because traditional smoking products still account for around 70% of operating profit. 

Meanwhile, the business is making good progress in selling its next-generation offerings, such as vapes, heated tobacco and oral nicotine. However, one ongoing uncertainty is the regulatory scrutiny the company attracts for all product categories, including the newer ones.

At any time, governments may pass laws to make smoking and vaping difficult for people. And the prospects of Imperial Brands could be damaged. If that happens, the firm’s big pile of debt could become problematic.

The company thinks it can enhance shareholder returns in the years ahead by using its steady cash flow to buy back its shares and increase dividends. But it’s worth noting that it trimmed the dividend in the pandemic and rebased it lower.

Since then, the shareholder payment has been increasing a bit each year. However, the dividend record of any company is a good indicator of the long-term health of a business. So the downwards rebasing is a reason for caution. 

Despite my concerns, the directors issued an optimistic outlook statement with the full-year results. And the company is cheaper now than it has been for years. Cash flow appears to be holding up well. And City analysts expect increases in the dividend ahead.

On balance, I think the stock is worth the further research time of passive income-seeking investors.

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.

Kevin Godbold has no position in any of the shares mentioned. The Motley Fool UK has recommended 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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