Shares in FTSE 100 tobacco and nicotine products manufacturer Imperial Brands (LSE: IMB) are down 15% from this year’s high. Five years ago, the stock was trading around £23.69.
This fall is in large part due to the broad decline in smoking globally. So the company, like all its major peers, is looking to gradually shift its business into non-combustible nicotine products.
How well it can achieve this remains a key risk for the stock. Another is its high level of debt. As of the end of Q3, Imperial Brands had around £10.1bn of debt. Against this, it has about £1.38bn in cash, giving a net debt of £8.72bn.
Two factors mitigate the debt risk here for me. First, its net debt has not increased from a year ago. And second, the company has a healthy enough EBITDA ratio (around 2.3).
Very undervalued against its peers
Positively in this context, its earnings have increased by an average of 10.9% a year over the past five years.
And over the past year, they have risen by 48.3%. This compares to a fall in earnings of over 4% for the tobacco sector.
Despite this, its share price remains at a huge discount to all but one of its key rivals.
Currently, it trades at a price-to-earnings (P/E) ratio of just 6.8. British American Tobacco is at 5.9, but Altria Group is at 8.6, and Philip Morris International is at 18.5. This gives a peer group average of 11.
To gauge what a fairer price for the stock should be I applied the discounted cash flow (DCF) model.
Using several analysts’ assumptions and my own gave a range of core assessments between 40% and 51% undervalued.
The lowest of these would give a fair value per share of £35.23, compared to the current £21.14.
This does not mean the shares will reach that price, of course. However, it underlines to me that they look very good value.
Broadly positive for potential share price gains in the coming year is a £1.1bn share buyback announced on 5 October. This will run until 30 September 2024.
High dividends
In 2022, the total dividend was 141.17p per share. Based on the current share price, this gives a yield of 6.7%.
For 2023, all dividend payments have been declared and total 146.82p. This provides a yield of 6.9% based on the present share price.
Both compare very favourably to the current 3.8% average yield of the FTSE 100.
In both years, these were well supported with respective dividend cover ratios of 1.88 and 1.9. Above 2 is considered good, while below 1.5 indicates the risk of a dividend cut.
For me, in my mid-50s, the risk in this stock is too much for the reward offered. The older I get, the less time I want to wait for a stock to recover from any major shocks.
Yields change with dividend payments and share prices, of course. So do companies’ growth prospects. And with all these factors, a stock’s risk-reward balance shifts.
If I were 10 or 20 years younger would I buy Imperial Brands shares? Probably, for both the yield and growth potential over the long term.
