Why I think this company’s share price and 7% dividend yield may make it the bargain of the FTSE 100

This unloved FTSE 100 (INDEXFTSE:UKX) stock has the potential to make investors very rich, believes G A Chester.

| 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.

The Imperial Brands (LSE: IMB) share price ended last week at 2,618p. This is 37% below its all-time high of 4,139p made in August 2016. As a result of the decline, I believe the tobacco stock could now be the bargain buy of the FTSE 100. Here’s why.

Dirt cheap

The first thing to note is that other tobacco companies’ shares are also trading well down from their previous highs. This applies not only to Imperial’s London-listed peer British American Tobacco, but also to overseas giants Philip Morris, Altria and Japan Tobacco. In other words, there are industry-wide reasons, as opposed to company-specific reasons, for why Imperial is currently unloved by the market.

As a business, it continues to perform well. When its shares were at their all-time high two years’ ago, it was set to post annual earnings per share (EPS) of 249.6p, and a dividend of 155.2p. When it releases its latest annual results tomorrow, City analysts are expecting EPS of 267p, and a dividend of 188p.

The combination of the rise in earnings and dividends and the decline in the share price means that while Imperial was trading on a price-to-earnings (P/E) ratio of 16.6, and a dividend yield of 3.7% when its shares were at their high, it’s now trading on a P/E of just 9.8, with a whopping 7.2% yield.

This compares favourably with British American Tobacco’s P/E of 11.4 and yield of 6%. But, in truth, both stocks appear dirt cheap by their historical standards and compared with other defensive businesses in the broad consumer goods sector.

Headwinds

For decades, tobacco companies have faced headwinds of increasing regulation and health education in the developed world. However, they’ve been able to mitigate the effect of this on sales volumes and revenues by consolidation in the industry, expansion in emerging markets, and the ability to increase prices in line with, or ahead of, inflation.

The development of lower-risk next generation products (NGPs) is likely to be another important tool in the armoury going forward. Imperial has begun the international rollout of its blu e-vapour brand. A current-year annualised exit run-rate of around £0.3bn revenue is set to accelerate in 2019 and beyond. The expected pace is reflected in management incentives to deliver compound annual growth of 35% to 150% over the three years to 2020. In addition, the company recently announced plans to launch Pulze, a heated tobacco product, early next year.

Rerating potential

The weakness in the share prices of Imperial and its peers seems to be due not only to the ongoing regulatory headwinds for traditional tobacco products, but also to uncertainty about how NGP markets will develop. For example, will ‘vaping’ products ultimately face the same restrictions as cigarettes, as some, like the World Health Organisation, are calling for?

On balance, I believe Imperial and others are likely to be able to meet future regulatory challenges and find ways to continue growing their earnings and dividends, as they have done in the past.

We’ve been in the situation before when market sentiment has dragged down the valuations of tobacco companies, only for sentiment to thaw and the stocks to rerate. On the view that there’s every chance history will repeat itself and that the rewards for investors would be substantial if it does, I’d be happy to buy shares in Imperial today.

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.

G A Chester 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

Investing Articles

Could the JD Sports Fashion share price double in the next five years?

The JD Sports Fashion share price has nearly halved in the past five years. Our writer thinks a proven business…

Read more »

Bus waiting in front of the London Stock Exchange on a sunny day.
Investing Articles

If interest rate cuts are coming, I think these UK growth stocks could soar!

Falling interest could be great news for UK growth stocks, especially those that have been under the cosh recently. Paul…

Read more »

Investing Articles

Are these the best stocks to buy on the FTSE right now?

With the UK stock market on the way to hitting new highs, this Fool is considering which are the best…

Read more »

Petrochemical engineer working at night with digital tablet inside oil and gas refinery plant
Investing Articles

Can the Centrica dividend keep on growing?

Christopher Ruane considers some positive factors that might see continued growth in the Centrica dividend -- as well as some…

Read more »

Smiling family of four enjoying breakfast at sunrise while camping
Investing Articles

How I’d turn my £12,000 of savings into passive income of £1,275 a month

This Fool is considering a strategy that he believes can help him achieve a stable passive income stream with a…

Read more »

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

2 top FTSE 250 investment trusts trading at attractive discounts!

This pair of discounted FTSE 250 trusts appear to be on sale right now. Here's why I'd scoop up their…

Read more »

Smiling young man sitting in cafe and checking messages, with his laptop in front of him.
Investing Articles

3 things that could push the Lloyds share price to 60p and beyond

The Lloyds share price has broken through 50p. Next step 60p? And then what? Here are some thoughts on what…

Read more »

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

£1,000 in Rolls-Royce shares a year ago would be worth this much now

Rolls-Royce shares have posted one of the best stock market gains of the past 12 months. But what might the…

Read more »