Tobacco is out of fashion, and Imperial Brands (LSE: IMB) shareholders have suffered of late. Over the past five years, the IMB share price is down more than 50%. Imperial Brands dipped a bit during the early days of the pandemic. But it’s hard to tell whether that’s got anything to do with Covid-19, or is just a continuation of the longer-term slide.
But it’s starting to look like things are picking up again. So far in 2021, IMB shares are up 8%. And over the past 12 months, we’re looking at an 18% gain. So what does Imperial Brands have going for it?
Well, profits, for one thing. Earnings fell a little in 2020, but the trend over the past decade has been upwards. Smoking is becoming increasingly unacceptable in developed Western countries. But in large parts of the world, it’s still big business. Premium brands are increasingly popular too, and that means bigger profit margins. Alternative tobacco products, like that vaping thing that’s catching on, are growing too.
Big dividend yields
And then there are dividends. The 2020 payment was rebased from the trend of the previous few years. But with the IMB share price so depressed, it still provided a yield of 10%. What’s more, it was covered 1.8 times by earnings, which suggests it should be sustainable.
Imperial brands enjoys healthy cash flow too. For the year to 30 September 2020, the company reported an underlying conversion rate of 107%. There is a downside to the cash situation, though, and that’s debt. Adjusted net debt reduced by around £1bn, but still stood at £11.1bn at year-end. While I like dividends, I increasingly prefer to see a company prioritising debt reduction ahead of them. I’d hope to see more of that in the coming years.
On the current IMB share price, we’re looking at a P/E multiple of only a little over six, based on adjusted earnings. I think that looks seriously cheap. The long-term FTSE 100 average stands at more than twice that. So what are the downsides?
Threats to the IMB share price
For one thing, regulatory threats are always hanging over the industry. That’s especially true in the USA, where there’s a whole litigation industry ready to jump on any opportunity. The same is true in other Western nations, though perhaps posing a less immediate threat. I’d expect any regulatory move to have at least a short-term effect on the IMB share price.
The obvious wider risk is the growing pariah status of tobacco, and I don’t see a change in that coming any time soon. I see two big questions. Firstly, how long will demand for actual cigarettes continue? In the developing world with its increasing wealth, I suspect for some time yet. And will alternative tobacco products grow strongly enough to compensate for slowing cigarette sales in developed nations? Of that, I’m more uncertain.
So does the current IMB share price attract me and will I buy? For ethical reasons, no. But apart from that, I’d be jumping on it and counting my potential years of fat dividends. First-half results are due on 18 May.