The Imperial Brands (LSE: IMB) share price offers one of the highest dividend yields in the FTSE 100. At the time of writing, the stock supports a dividend yield of 9.4%, compared to the market average of around 3.4%.
Such a high dividend can be a sign that the market doesn’t believe the distribution is sustainable. I don’t think that’s the case with Imperial. Today, I’m going to explain why.
One of the best ways to understand whether or not a company can sustain its dividend is to look at its cash flow figures.
Cash flow tells us how much cash a business is taking in and spending. Meanwhile, profit tells investors how much money is left after all expenses are paid. Profit figures are an excellent way to assess the success of a business and place a value on the Imperial Brands share price.
However, cash flow is far more essential to keep a company operating on a day-to-day basis. If a company doesn’t have any cash, it’ll struggle to pay suppliers, workers and other creditors. No business can last very long without cash coming in through the door.
Imperial is a cash cow. In the company’s last financial year, which ended on the 30 September 2020, the group’s free cash flow, the amount of money that’s left after paying all expenses and investing for growth, was around £2.6bn. Of this, the firm paid £1.7bn to shareholders via dividends.
As such, it looks as if its dividend is well covered by free cash flow from operations.
In its latest trading update, Imperial also said it expects to report “low-to-mid single-digit growth” in operating profit for its current financial year. That suggests to me cash flow will remain strong and should help support the dividend payout.
Imperial Brands share price risks
Having said all of the above, it’s clear the company is facing some significant risks, which may limit its ability to distribute large amounts of cash in the future. Cigarette consumption around the world seems to be in a slow but terminal decline.
What’s more, the growth of so-called reduced-risk products, such as e-cigarettes, which were supposed to replace cigarette sales, haven’t lived up to expectations. I think these headwinds will continue to weigh on the Imperial Brands share price for the foreseeable future.
Also, the company has £10.3bn of borrowing. Sustaining this debt is costing around £560m per annum. Sooner or later, the business will have to pay off these creditors. So there’s a chance Imperial may have to reduce shareholder returns to pay off its borrowings.
These challenges could impact Imperial’s ability to meet its dividend targets.
The bottom line
It’s clear to me that some investors might be avoiding the Imperial Brands share price due to the risks outlined above. These risks may mean the company isn’t suitable for all investors. However, I’d buy the stock today based on its cash generation and current dividend yield.
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Rupert Hargreaves owns no share mentioned. Imperial brands share price looks incredibly attractive has a dividend investment in the current interest rate environmentThe 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.