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Here’s why I’d buy Imperial Brands plc after 10% FY dividend hike

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Tobacco giant and dividend machine Imperial Brands (LSE: IMB) has looked less than mighty in recent times, its stock plunging almost 20% in the past year even as the FTSE 100 flies to new highs. However, today’s preliminary final results for the year to 30 September show it remains a tempting buy-and-hold for the long term.

Imperial power

The results were headlined in block capitals “AN IMPORTANT YEAR OF PROGRESS”, in case we failed to get the point that this is a business in progress, rather than one at the top of its game. Imperial Brands has been helped out by the weak pound, which boosted the value of its overseas earnings, but measured at constant currency today’s results are underwhelming. It admits as much, noting that constant currency results have been “impacted by increased investment and a tough trading environment”. In other words, brace yourselves.

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The headline number is negative: a 4.1% drop in tobacco volumes to 265.2bn on 2016. However, its key Growth Brand volumes rose 5.5% to 159.6bn. Tobacco net revenue rose 8.2% to £7.56bn but this was mostly due to the currency kicker, converting into a 2.6% drop at constant exchange rates. Similarly, total adjusted operating profit rose 6.2% to £3.76bn but dipped 2.4% without that FX kicker. Total adjusted operating profit and adjusted earnings per share showed a similar pattern.

Battle of the brands

However, the group’s capital discipline delivered 91% cash conversion which supported a 10% hike in the dividend per share to 170.7p. Adjusted net debt also fell £800,000 to £12.1bn. The results pointed to a brighter future with talk of a “second half improvement in volumes, net revenue and profitability”.

CEO Alison Cooper repeated the “year of progress” mantra in her comments, stating that the company was building on previous work to strengthen its brand portfolio, boosting its key brands and gaining share in most of its priority markets. It also “continues to take decisive cost action to mitigate a tough trading environment and to protect our investments,” she added.

Heat is on

Increased investment hit this year’s revenue and profits but should strengthen the business in the longer run, as Imperial Brands develops next generation products including heated tobacco trials. It is stepping up its activities in this area, with planned e-vapour launches and consumer trials of heated tobacco products aimed at enhancing shareholder value.

Tobacco is in long-term decline in the West, and the trend should extend to emerging markets as customers become more health-conscious. However, Imperial Brands still generates huge sums of cash and can survive by boosting market share, marketing premium brands, cutting costs and promoting a new generation of tobacco products.

Up in smoke

Importantly, Imperial Brands has reaffirmed its generous policy of “growing dividends by at least 10% per year over the medium term”. It now yields a forecast 5.7%, covered 1.6 times, which City analysts reckon should hit 6.2% in 2018. Only a handful of companies pay more, such as this 6.5% yielder. Management has a fight on its hands with tobacco volumes expected to decline further but trading at 11.2 times earnings, the scale of the challenge is reflected in the price.

The market’s likes today’s results, with the stock up 2.83% in early trading, and with reason.

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Harvey Jones has no position in any of the shares mentioned. 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.

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