One 6% yielder I’d trade for Imperial Brands plc

Roland Head takes a look at a potential value trap and revisits the investment case for Imperial Brands plc (LON:IMB).

| More on:

The content of this article was relevant at the time of publishing. Circumstances change continuously and caution should therefore be exercised when relying upon any content contained within this article.

When investing, your capital is at risk. The value of your investments can go down as well as up and you may get back less than you put in.

Read More

The content of this article is provided for information purposes only and is not intended to be, nor does it constitute, any form of personal advice. Investments in a currency other than sterling are exposed to currency exchange risk. Currency exchange rates are constantly changing, which may affect the value of the investment in sterling terms. You could lose money in sterling even if the stock price rises in the currency of origin. Stocks listed on overseas exchanges may be subject to additional dealing and exchange rate charges, and may have other tax implications, and may not provide the same, or any, regulatory protection as in the UK.

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More.

One of the investing lessons I’ve learned over the years is that cyclical businesses usually take longer to hit rock bottom than you’d expect.

Pub groups are a good example of this. Shares of Greene King (LSE: GNK) have now fallen by 25% so far this year. They’re worth around 45% less than when they peaked at the end of 2015.

Is this stock finally cheap enough to buy? Perhaps. But today’s figures suggest to me that trading is likely to remain tough as we head into 2018.

Mixed figures

Adjusted pre-tax earnings fell by 8% to £127.9m during the 24 weeks to 15 October, while revenue fell by 1.2% to £1,031.4m. This may not seem like a big drop in sales, but it’s important to remember that to keep pace with inflation, sales should be rising by a few percent at least.

Group costs are expected to rise by £60m this year, but management expects “to deliver £40m-£45m of cost savings,” to offset some of these increases.

One concern for me is that Greene King is still in the process of integrating and optimising its pub brands, following the 2015 acquisition of Spirit Pubs. This process inevitably carries upfront costs and some risk, even if the end result is successful.

A turnaround opportunity

The Suffolk-based group’s net debt is now 4.2x times earnings before interest, tax, depreciation and amortisation (EBITDA), up from 4 times at the end of last year. Management expects this ratio to be “relatively stable”, but I’m concerned it could rise further.

The interim dividend has been left unchanged at 8.8p. Assuming the final dividend is also flat, the stock now offers a yield of 6.3%. Greene King says that this is “attractive and sustainable”, but I’d caution that if trading remains difficult next year, this payout could come under pressure.

The opinion coming out of the City after today’s results seems to be that analysts’ earnings forecasts are now likely to fall. So the stock’s forecast P/E of 8 may not be quite as cheap as it seems.

I expect Greene King to deliver a medium-term recovery. But I don’t think there’s any rush to buy just yet.

A Woodford pick I’d buy

If you’re happy to invest in sin stocks, then I believe tobacco giant Imperial Brands (LSE: IMB) could prove a more profitable alternative to Greene King.

The group’s share price dipped earlier this week after wholesaler Palmer & Harvey went into administration. P&H was one of the main distributors of tobacco products in the UK, and Imperial was forced to admit that this situation is likely to result in a one-off loss of £160m of operating profit.

However, the group has contingency plans in place for distribution and this loss looks small when measured against last year’s adjusted operating profit of £3,761m. The group’s overall valuation also looks modest when compared to key rivals.

Imperial stock currently trades on a forecast P/E of 11, with a prospective yield of 6.1%. In contrast, British American Tobacco trades on 17 times forecast earnings with a yield of 3.8%.

In my view, there’s no obvious reason for Imperial to trade at such a big discount. That’s a view shared by fund manager Neil Woodford, who bought more shares in October at what he described as an “appealing and unjustified share price”.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Roland Head 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.

More on Investing Articles

Black woman using loudspeaker to be heard
Investing Articles

I was right about the Barclays share price! Here’s what I think happens next

Jon Smith explains why he still feels the Barclays share price is undervalued and flags up why updates on its…

Read more »

Investing Articles

Where I’d start investing £8,000 in April 2024

Writer Ben McPoland highlights two areas of the stock market that he would target if he were to start investing…

Read more »

View of Tower Bridge in Autumn
Investing Articles

Ahead of the ISA deadline, here are 3 FTSE 100 stocks I’d consider

Jon Smith notes down some FTSE 100 stocks in sectors ranging from property to retail that he thinks could offer…

Read more »

Young female business analyst looking at a graph chart while working from home
Investing Articles

Why I think Rolls-Royce shares will pay a dividend in 2024

Stephen Wright thinks Rolls-Royce shares are about to pay a dividend again. But he isn’t convinced this is something investors…

Read more »

Investing Articles

1 of the best UK shares to consider buying in April

Higher gold prices and a falling share price have put this FTSE 250 stock on Stephen Wright's list of UK…

Read more »

Person holding magnifying glass over important document, reading the small print
Investing Articles

The market is wrong about this FTSE 250 stock. I’m buying it in April

Stephen Wright thinks investors should look past a 49% decline in earnings per share and consider investing in a FTSE…

Read more »

Black father and two young daughters dancing at home
Investing Articles

1 FTSE 250 stock I own, and 1 I’d love to buy

Our writer explains why she’s eyeing up this FTSE 250 growth phenomenon, and may buy more shares in this property…

Read more »

View of Tower Bridge in Autumn
Investing Articles

The FTSE 100 is closing in on 8,000 points! Here’s what I’m buying before it’s too late!

As the FTSE 100 keeps gaining momentum, this Fool is on the lookout for bargains. Here's one stock he'd willingly…

Read more »