I’m looking for the best share to buy in the month ahead, and where better to start than by looking at last month’s biggest flop?
I’ve think of myself as a contrarian investor, preferring to snap up out-of-favour stocks in the hope of getting them on the cheap. The theory is that I’ll enjoy stronger growth when sentiment turns, along with a bigger dividend yield.
It doesn’t always play out like that. Share prices don’t fall for nothing. The challenge is working out whether the bad news is temporary or terminal. Not easy.
Imperial Brands falls
I was surprised to find Imperial Brands Group (LSE: IMB) is set to be May’s worst FTSE 100 performer, with its price falling 7.87%.
That’s a poor showing in a good month for the index that’s up 3.25% since April. In total, only 18 out of 100 shares ended up in the red, but none did worse than this.
Imperial’s half-year results on 14 May were poorly received, with the stock ending the day down more than 7%.
Adjusted operating profit missed forecasts and Imperial Brands announced the upcoming departure of CEO Stefan Bomhard. He’ll be replaced by group finance chief Lukas Paravicini.
Reported revenue fell 3.1% to £14.6bn, although earnings per share edged higher.
The company is still generating huge amounts of cash, with £2.4bn of free cash flow over 12 months and a bumper conversion rate of 99%. This is helping it fund a £1.25bn share buyback.
Tobacco volumes continued to decline, although “strong pricing” more than made up for it.
Next-generation products grew nicely too, with revenues up 15.4%. Management said it remains on track to meet full-year guidance, but investors still recoiled.
Valuation looks tempting
After a strong 12 months, the shares were due a breather. They’re still up 46% over one year and 90% over five. So it’s not hard to see why investors are cautious.
The long-term issue that smoking kills isn’t going away. Tougher regulation is a constant threat, and while pushing into e-cigarettes and other alternatives brings opportunities, regulators are watching closely.
So today’s low price-to-earnings ratio of just 9.4 doesn’t necessarily reflect a bargain. More like a risk premium. The dividend yield of 5.45% is among the highest on the FTSE 100 today. It’s not as high as it was though, as it’s been squeezed by recent share price growth.
Some analysts remain optimistic. On 23 May, RBC Capital lifted its price target to from 2,100p to 2,400p, citing steady progress on market share and an improving next-generation portfolio, especially in the US. It reckons operating profit growth will pick up in the second half. Time will tell.
Returns still flowing
Personally, I don’t invest in big tobacco, but if I did, I would consider buying Imperial Brands after May’s pullback. The business remains a cash machine, and the drop in share price may open the door for long-term income seekers.
The 10 analysts serving up one-year share price forecasts have produced a median target of 3,327p. If they’re right (always a massive ‘if’), that would be a solid increase of around 15% from today. So investors could potentially get some growth too.
Imperial Brands doesn’t have to be the best, but does look like one to consider in June. Sadly, it’s not for me.
