The share price of FTSE 100 tobacco group Imperial Brands (LSE: IMB) has recovered from a low of 1,847p made towards the end of June. Nevertheless, at a current 2,145p, the company remains on a cheap price-to-earnings (P/E) ratio and high dividend yield.
City analysts expect it to post adjusted earnings per share (EPS) of 282p for its financial year ending 30 September. This gives a P/E of 7.6. Meanwhile, management has committed to a 10% increase in the dividend. This makes the prospective payout around 207p, giving a yield of 9.7%.
Of course, a single-digit P/E and a yield pushing 10% suggest the market isn’t exactly taking an optimistic view of Imperial’s future earnings growth and the sustainability of its dividend. However, management is confident about the prospects for the business, and the investment case is compelling, in my opinion.
Earnings growth prospects
The challenges facing the tobacco industry are widely known. Yet Imperial has a long record of delivering strong price/mix growth to offset industry volume declines. And the rising revenue has fed down to increasing profits and dividends.
Imperial’s been led for the last nine years by Alison Cooper, who joined the company in 1999 and held a number of senior roles prior to her appointment as chief executive. She knows the company and the industry inside out.
In a Q&A session with analysts at the Deutsche Bank Global Consumer Conference in Paris in June, Cooper provided a very good overview of Imperial’s positioning in the industry. She also discussed her confidence in the company’s ability to continue delivering “robust, but modest growth” from traditional tobacco products alone, with next-generation products being “an additive business on top of that tobacco delivery, really taking our revenue growth up and as of next year, starting to add to profits as well.”
If Cooper is right about the outlook, Imperial’s P/E of 7.6 suggests the market is being way too pessimistic about the company’s earnings-growth prospects.
Imperial’s chief financial officer, Oliver Tant, also participated in the June Q&A, and had some very comforting things to say about the dividend. In particular, he said: “There is no issue here about the affordability of our dividend given our current performance and our anticipated performance as we move forward.”
Tant explained that having increased the dividend 10%+ a year for the last 10 years, the company sought feedback on future policy from “a relatively large group of shareholders” earlier this year. He said these shareholders were “less concerned about the ongoing nature of our dividend promise, beyond it being progressive and beyond any concern about a cut, which is a very remote if non-existent possibility.”
This provides an insight into Imperial’s new progressive — but more flexible — dividend policy (from fiscal 2020), announced a couple of weeks ago and discussed in detail by my Foolish colleague Roland Head.
With a 9.7% yield available at the current share price, and a cut “a very remote if non-existent possibility” in the words of Tant, I think the market is being way too pessimistic about Imperial’s dividend, as well as its earnings growth prospects.
I believe the low P/E and high yield make the stock a bargain. I rate it a ‘buy’.
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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.