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Why I’m considering selling Imperial Brands plc

Imperial Brands (LSE: IMB) is one of the FTSE 100’s dividend champions. The tobacco company has a reputation for slow and steady returns, and management is committed to returning a significant amount of profits to investors via dividends. 

Indeed, at the time of writing shares in the company support a dividend yield of 5%, which is a little more than 1% above the market average, and the payout is covered 1.6 times by earnings per share. Also, management has committed to payout rises of 10% per annum for the foreseeable future.

But despite Imperial’s dividend attraction, the company’s fundamentals are mixed. As one of the world’s largest tobacco companies, it makes billions from the sale of high margin cigarettes. While this business has historically been extremely lucrative, attitudes towards smoking are changing rapidly and Imperial, which is developed market-focused, is suffering.

Falling profits 

Imperial’s half-year results for the six months ended 31 March, clearly show that the company is having problems. While headline figures all showed growth thanks to the depreciation of the pound, on a constant currency basis, tobacco net revenue declined 5.5%, adjusted operating profit fell 7.6%, and adjusted earnings per share fell 5.9%.

Management is all too aware of the decrease in tobacco sales around the world, and they have pushed the firm into other businesses in an attempt to diversify. The group’s Fontem Ventures division is responsible for Imperial’s e-cigarette development and recently-launched caffeine products, but these are still relatively tiny parts of the overall business.

The rest of the tobacco sector has been experimenting with so-called reduced risk products, primarily heat rather than burn technology that reduces the amount of toxic chemicals released from cigarettes. Peer Philip Morris has spent $3bn developing this technology. After launching its first product in Japan last year, the company has sold millions of them.

Imperial has stayed away from this avenue so far, and a reluctance to enter this market could cost the company hundreds of millions of dollars as health-conscious consumers stub out cigarettes. Imperial can ill afford to miss out on this opportunity. As noted above, the company’s revenue and profit is already coming under pressure, and management quickly needs to come up with new ways to reignite growth. A weaker pound has helped temporarily boost profits, but this may not last forever.

Mixed outlook 

Considering all of the above, while it looks like a good dividend stock today, the company’s long-term potential remains unclear. The market seems to hold the same opinion, as shares in Imperial currently trade at a forward P/E of 12.8, which makes it one of the cheapest consumer goods stocks in Europe.

Whether or not the market can regain confidence in the company depends on management’s next moves. The company needs to find new growth opportunities or earnings will continue to slide, jeopardising both the company’s dividend objectives and its actual existence.

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Rupert Hargreaves owns shares in Imperial Brands. The Motley Fool UK has recommended Imperial Brands. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.