Where can I get a 9% dividend yield today? There aren’t many options I’d be comfortable considering. But one FTSE 100 share that ticks most of the right boxes for me is Imperial Brands (LSE: IMB).
As a big tobacco stock, Imperial obviously carries certain risks. The biggest worry is probably that global smoking rates will fall faster than expected. But a recent update from the company has convinced me the outlook for the foreseeable future is probably quite safe.
Focus on what works
Imperial’s new chief executive Stefan Bomhard has revamped the group’s strategy and says he’ll focus more closely on tobacco. Investment in newer products such as vapes and heated tobacco will be “more disciplined” and targeted to markets with proven demand.
It might seem odd for Imperial to focus on selling cigarettes, given the proven health risks and the long-term decline in smoking rates in most countries. But this is still a big business. Imperial sold 239bn cigarettes last year, generating revenue of £32,562m and an operating profit of £2,731m.
Excluding the cost of tobacco duty and other taxes, which the company passes directly to governments, net sales were £7,985m. This tells me Imperial’s business had an underlying operating profit margin of 34% last year. There aren’t many FTSE 100 firms that can match this.
Bomhard expects to cut up to £150m of costs by 2023, while making selected investments in new products and marketing. He believes the company can deliver flat profits next year, with a return to modest profit growth between 2023 and 2025.
What could go wrong?
I have two main concerns about owning this FTSE 100 share. The first is that I think Imperial Brands will always be a mature business in slow decline. I might be wrong, but I think it’s sensible to take this view when trying to value the shares.
My second concern is that the tobacco sector could become even more unpopular with investors. I think it’s fair to say some investors will be uncomfortable with the social and ethical implications of this business.
I also think there’s a chance banks and other lenders could start to charge a premium for lending to businesses which don’t satisfy environmental, social and governance (ESG) criteria. If I’m right, then tobacco firms including Imperial Brands could see their financing costs rise over the coming years. Higher borrowing costs could reduce the amount of spare cash available for shareholder returns.
I’d buy this FTSE 100 share
Imperial Brands faces some unusual risks for a FTSE 100 company, but I think the stock’s valuation reflects this. Despite a stable outlook, the stock currently trades on just six times 2021 forecast earnings and offers a 9.6% dividend yield.
This dividend looks safe enough to me and I believe the stock’s low valuation provides a reasonable margin of safety.
I already own some Imperial stock. Based on the latest guidance from the company, I’m happy to keep holding this stock and collecting my dividends.
