Why I’m bullish on this 4.7% yielder

Tobacco is one of the few sectors which could record strong growth in 2017. Since the economic outlook is highly unclear thanks to Brexit and political uncertainty in the US, tobacco companies could become more in demand among investors. They offer stable business models, as well as growth potential from e-cigarettes. And since inflation is expected to move higher this year, the Imperial Brands (LSE: IMB) 4.7% yield may also prove extremely popular.

A popular industry

Sales of cigarettes are unlikely to be affected by potential economic challenges that may lie ahead. During recessions and economic booms, consumption of cigarettes changes very little. As such, Imperial Brands has a stable business model which has excellent defensive characteristics.

If share prices continue to be volatile, investors may seek out risk-off companies that offer more certain futures. And since Imperial Brands, as well as sector peer British American Tobacco (LSE: BATS), have scope to raise prices across the regions in which they operate, sales and profitability from tobacco products should rise over the medium term.

Growth potential

Alongside pricing power is growth potential within the e-cigarette space. While rising demand for e-cigarettes has moderated somewhat in recent years, they continue to offer double-digit growth for Imperial Brands. It owns one of the most popular e-cigarettes in the US, blu, and this could enable it to outperform the wider market when it comes to earnings growth in the medium term.

Of course, e-cigarettes could prove to be just the start of a period of intense innovation within the tobacco industry. Consumers across the globe are becoming increasingly health conscious and this could spur development of more products that offer lower health risks. Since Imperial Brands has a sound balance sheet and strong cash flow, it seems to have the financial firepower to invest in future growth and remain a major player in an evolving tobacco industry.

Dividend growth

As well as a 4.7% yield, Imperial Brands is forecast to raise dividends by 10% per annum over the next two years. That’s slightly ahead of British American Tobacco, which is forecast to raise them by 9.8% per year over the same time period. However, with Imperial Brands having a yield that’s 1% higher than its sector peer, it could prove to be the better buy over the long run. That’s especially the case since British American Tobacco will integrate Reynolds into its business, which could increase its risk profile slightly in the coming months.

With inflation set to rise to as much as 3% this year, Imperial Brands could become an extremely useful stock to own. It has a relatively high yield, strong dividend growth potential, bright earnings growth prospects and a stable business model. As such, now could be a good time to buy it and its shares look set to beat the wider index over the medium term.

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Peter Stephens owns shares of British American Tobacco and Imperial Brands. The Motley Fool UK has recommended Imperial Brands. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.