No dividend is ever guaranteed to last. Many investors know that in theory but sometimes have an overly optimistic view of what might actually happen in practice. Back in 2020, shareholders in Imperial Brands (LSE: IMB) learnt the hard way, when the tobacco company slashed its payout per share.
Since then, it has been growing. The company’s interim results announcement Tuesday (18 November) included a 4.5% increase in the interim dividend per share. That is in line with Imperial Brands’ stated goal of growing its dividend annually.
How long could that last?
A business with a fundamental challenge
Imperials Brands’ 2020 dividend cut followed years of annual double digit percentage growth. That was increasingly out of sync with what the business was able to deliver, so it was only a matter of time before that policy was abandoned. Even so, the cut was a bitter blow.
One of the challenges back then was not just that the dividend policy had been ambitious, but also reflected the shifting dynamics of the tobacco industry.
Five years on, that poses a more acute risk than ever, and the interim results demonstrate why. Revenues fell year-on-year, albeit by only 1%. But tobacco volumes fell faster, declining 2%.
For now, Imperial (like many competitors) has been largely able to mitigate falling sales volumes by raising cigarette prices. But over time that strategy could become harder if smokers find the cost increasingly difficult to draw on.
Strategy’s been delivering
Imperial’s approach to market decline has been to try and grow its cigarette market share in key markets. It also has a non-cigarette portfolio, though has often seemed less ambitious in that regard than UK rival British American Tobacco.
In the short term, that has allowed Imperial to focus more on massively profitable cigarettes while the business model for vapes remains unproven. But that could mean Imperial has its work cut out down the line if competitors are better established than Imperial’s non-cigarette formats.
Still, with its net revenue from non-cigarette products showing 14% year-on-year growth, its sometimes-lacklustre-feeling approach to moving beyond cigarettes actually seems to be doing well from a sales perspective.
A one-off tax refund flattered free cash flows, which came in at £2.7bn. But even excluding that, the company demonstrated its strong cash generation capability. Cash flows from operating activities rose to £3.3bn.
Strong dividend prospects
That matters when it comes to the Imperial Brands dividend, as sustaining let along growing a payout over the long run relies on adequate free cash flows.
At £1.6bn, the cost of shareholder dividends during the period was comfortably covered by free cash flows.
If Imperial can continue to use its pricing power to blunt the impact of declining cigarette volumes while growing its non-cigarette business, I think it could potentially maintain or even keep growing its dividend for many years to come.
The current yield is 5.8%, well above the FTSE 100 average. It is also in line with British American’s.
But having more than doubled in five years, the current Imperial Brands share price does not grab me as an obvious bargain like it once did. So for now, I will not be investing.
