Investors are rightly suspicious of stocks offering king-sized yields, and a double-digit payout certainly falls into that category.
Tobacco giant Imperial Brands Group (LSE: IMB) currently yields a regal 10.2%, while its forecast yield stands at an even mightier 11.2%, covered 1.4 times. Still, you are right to approach this stock with caution. Especially with its share price down 30% over the last year, and 45% over three years. Its market cap of £17.23bn simply isn’t as big as it was.
Investor sentiment took another knock late last month, when the group cut annual revenue guidance in light of challenges in the US vaping market and weakness in Africa, Asia and Australasia. Group net revenue for the year to 30 September is now expected to grow at around 2%, with earnings per share broadly flat.
Imperial Brands has been caught up in the US regulatory assault on vaping, or Next Generation Products (NGPs), as it calls them. The market is slowing, as a growing number of wholesalers and retailers no longer order or promote vaping products.
Despite this, the group still claims it can build “a strong and profitable NGP business in a rapidly evolving market”, and expects to grow net revenues from this source by a massive 50% this year, even if that’s below expectations.
Imperial Brands is increasing brand investment and consumer promotions, but sales of Blu rose less than expected, amid competitor discounting. NGP growth looks more promising in Europe and Japan, and many people remain bullish about tobacco stocks, including G A Chester, who believes pricing power can offset volume declines.
He still rates the stock a ‘buy’, but others fear share prices could ultimately fall to zero, as smoking is in terminal decline. Yet both British American Tobacco and Imperial Brands still have plenty to offer investors, distributing a combined total of £6bn worth of dividends in 2019. Imperial Brands’ asset divestment programme is expected to realise up to £2bn by May next year.
Many will argue that regulatory threats are already priced in, given recent sharp share price falls. Imperial Brands currently trades at just 6.4 times forward earnings, a fraction of the 17.17 times seen across the FTSE 100 as a whole.
This is seriously cheap, while its double-digit yield is far above the FTSE 100 average of 4.7%. So you get a low price, and high income. Earnings per share are expected to grow a steady 3% this year, and 5% next. Incredibly, the yield is on course to hit 12.2% in 2020.
Growth thereafter may slow after the group’s (sensible) recent decision to abandon its long-running policy of increasing the payout by 10% a year. From 2020, it will increase its payout in line with profit growth, but should still remain a hugely attractive income stock.
Net debt is high at £13bn, around 75% of its market cap. Yesterday, chief executive Alison Cooper announced that she was stepping down after nine years, a sign that a rethink is required. Smoking is in long-term decline, and I do not see that changing. The future could be tricky, but I think Imperial Brands’ massive dividend income still outweighs the risks.
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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.