Lockdowns continue globally and predictions on the state of the economy are becoming increasingly grim. FTSE 100 companies that were earlier confident of riding out of this difficult phase are now less so. One of these is the tobacco biggie Imperial Brands (LSE: IMB).
Until a few weeks ago Imperial appeared quite confident of its position. It said that the Covid-19 pandemic had had no material impact on its business. It continued to pay impressive dividends in line with that. As a result it had one of the highest dividend yields among the set of FTSE 100 companies.
Imperial Brands reduces dividends
But Imperial wasn’t quite so upbeat earlier this week, when it posted its latest results. It cut its dividend by a third, which is a key reason the IMB stock is so attractive. According to a Financial Times report, this is the first time it has done so in the 24 years since it was first listed on the stock exchange. It’s unsurprising that a sharp drop in share price followed the dividend cut.
This appears like a straightforward case of yet another FTSE 100 company slashing dividends as the recession takes its toll on business. But I don’t think it is. Imperial Brands had already changed its dividend policy last year. It had said that it will link dividends to income going forward. Its profits, and relatedly, earnings per share had fallen in the half-year ending on 31 March 2020. This in itself is reason to activate its progressive dividend policy.
Strengthening its financial position
In the update it mentions that the dividend has been cut to “accelerate debt repayment”. Imperial’s debt has risen compared to last year. It does seem to have been top of the IMB management’s mind. Less than a month ago, it hived off its premium cigars business. In the news release announcing this sale, it said that the proceeds will go towards repaying debt as well. I think it’s good for long-term investors if IMB’s financial position is being strengthened, even if that means a dividend cut.
High dividend yield compared to FTSE 100 peers
Last, but not the least – even after the cut the dividend yield is still quite impressive at almost 9% at the last close at time of writing. That said, I think it’s important to remember that the cigarette market will become smaller over the next decades. It’s with this in mind that tobacco companies have started pivoting towards next generation products (NGP). But there’s bad news on that front in the latest update.
IMB says in its latest release that NGPs have seen a “poor return on investment”. It remains to be seen whether it will be able to manage the transition in the future. But, I do believe that with the next three- to five-year investing horizon in mind, IMB continues to remain a good income stock.
Manika Premsingh 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.