Imperial Brands (LSE:IMB) is currently the sixth highest yielding blue-chip enterprise in the FTSE 100 stock right now. And since the start of the year, shares are up almost 18%. That’s more than double what its parent index typically delivers in a year, both in terms of capital gains and yield!
So is this a screaming buying opportunity for income investors?
Advantages of investing in tobacco
As investors have become more health-conscious over the years, tobacco companies aren’t on everyone’s wishlist. The rise of environmental, social, and governance (ESG) investing strategies has added some stigma on these enterprises, which isn’t helpful for management teams looking to increase the stock price.
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However, this lack of interest has also been a bit of a blessing for income investors. As there’s less interest in owning tobacco stocks, these shares often trade at low multiples, paving the way for higher yields. This is why shareholders have enjoyed payouts ranging 6-9% since 2018.
A new spark of growth
Opponents of this enterprise often argue that the tobacco industry’s slowly shrinking. And looking at volumes, there’s an argument to be made here. Imperial Brands has suffered a steady decline in combustible product volumes for several years now.
So far, this decline’s been managed and offset through price increases that have enabled dividends to keep on flowing. However, management isn’t blind to the changing landscape. And a lot of funding’s being channelled into non-combustible products such as vapes in the group’s Next-Generation Products (NGP) segment. So far, this decision’s proving quite lucrative.
NGP net revenue over the six months ended March came in 16.8% higher, beating initial expectations. That’s quite significant given its chief rival, British American Tobacco, seems to be struggling to meet its targets with its own range of NGP products.
It’s worth pointing out that analysts at Barclays have started speculating that Imperial Brands may be on track to outgrow its larger competitor in the long run. If that proves accurate, some tremendous growth may lie ahead.
What could go wrong?
As impressive as the double-digit growth NGP’s delivering, it’s important to put things into context. It still remains a relatively small part of Imperial’s revenue stream, with traditional tobacco the primary driver of cash flow. Not to mention this segment remains unprofitable.
If management can keep up its current momentum, this balance might shift within a few years, especially since NGP losses are also shrinking. However, the impact of increasingly strict regulation within this space introduces a lot of long-term uncertainty.
Suppose Imperial Brands cannot transition away from cigarettes before regulator pressure causes combustible volumes to drop significantly. In that case, today’s mighty dividend yield may end up on the chopping block.
The bottom line
All things considered, I’m cautiously optimistic about the future of this rising tobacco enterprise. It seems to be better positioned than its main rival, with a stronger grip on the non-combustible market, I feel. However, the long-term uncertainty gives me pause.
So while I’m personally not interested in adding this enterprise to my portfolio, other income investors may want to take a closer look.
