The Motley Fool

This FTSE 100 stock could jump 50% and yields 7.5%

Over the past two years, shares in Imperial Brands (LSE: IMB) have produced one of the worst performances in the FTSE 100. Excluding dividends, since October 2017, the stock has declined 32%, underperforming the FTSE 100 by 26%.

Imperial isn’t the only tobacco stock that has suffered during this period. Its only other London listed peer, British American Tobacco, has seen its shares decline 29% over the past two years, and by 27% over the past 12 months, excluding dividends.

It’s difficult to pinpoint the exact reason why both companies have fallen out of favour with investors, but I can hazard a guess.

Policymakers around the world are taking an increasingly hard line towards tobacco products, and there’s a genuine threat that cigarettes could be banned altogether in some countries. Imperial’s lack of preparation for the future seems to be scaring investors away.

Planning for the future

Of the three leading international tobacco companies outside of China, Imperial is generally considered to be the most behind when it comes to the development and production of smoking alternatives, such as vaping pens and heated tobacco devices. British American and Philip Morris have been working to grab market share in these sectors for some time, leaving Imperial playing catch up.

To try and meet investor concerns, the company’s management is ramping up the production and development of so-called new generation products (NGP). In a recent investor presentation, Imperial announced that it would bring out new vaping devices as part of its blu e-cigarette brand, and unveiling a new device called Pulze, which heats tobacco rather than burning it, as part of the assault on the NGP market.

These new offerings could deliver compound annual revenue growth of 35% to 150% over the next three financial years, the company believes. If these forecasts come to fruition, NGPs could make up as much as 17% of total sales by 2020.

Growth potential 

If Imperial can successfully dominate the NGP market, I believe the stock could rocket. Right now, the shares are changing hands for just 9.9 times forward earnings which, in my mind, is suitable for a low- or zero-growth business, but gives no credit whatsoever to the growth potential here. 

The global NGP market is still in its infancy, worth roughly $4bn annually, according to Imperial’s analysis. If current trends continue, this market could grow to be a sizable $30bn by 2020 in the best case, according to management estimates.

If the company can capitalise on this growth, and see it filter through to the bottom line, I believe the stock is likely to re-rate substantially higher. Its long term average P/E is closer to 15, which implies a share price of 3,975p, up just over 50% from current levels. And in the meantime, while investors are waiting for a re-rating, the shares support a dividend yield of 7%, rising to 7.5% for 2019, according to the City’s projections.

A possible upside of 50%, coupled with a 7.5% dividend yield, are just two of the reasons why I’m bullish on this FTSE 100 income champion.

You Really Could Make A Million

Of course, picking the right shares and the strategy to be successful in the stock market isn't easy. But you can get ahead of the herd by reading the Motley Fool's FREE guide, "10 Steps To Making A Million In The Market".

The Motley Fool's experts show how a seven-figure-sum stock portfolio is within the reach of many ordinary investors in this straightforward step-by-step guide. Simply click here for your free copy.

Rupert Hargreaves owns shares in Imperial Brands and British American Tobacco. 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.