As supply chains snarls continue to disrupt businesses while Europe’s economies buckle under the weight of rapidly escalating energy costs, the specter of a global recession is fast becoming a reality. Imperial Brands PLC (IMBBF, Financial) (LSE:IMB, Financial) offers investors a high-yielding dividend haven in an economic environment of uncertainty, declining earnings growth and overall poor total returns.
Imperial is a U.K.-based tobacco company whose cigarette brands include Winston, JPS, L&B and Gauloises. The company is in the early stages of moving out of the corporate culture of traditional combustible cigarette products and developing alternatives or next-generation products such as vaping materials and oral nicotine substitutes.
Traditional cigarette products have historically proven to be one of the most recession-resistant industries. Consider Imperial’s recent performance against the S&P 500 Index as well as the FTSE 100 Index, which tracks large-cap U.K. companies. Year to date, the S&P 500 has declined almost 20%, while the FTSE has fallen 3.2% and Imperial has surged 17%.
The stock is relatively cheap on a historical price-earnings basis, currently selling at 9.6 for the trailing 12 months, which, as the chart below reveals, is substantially lower than its historical three-year peak of 19.42. Part of the reason for the relatively low price-earnings ratio is due to the rapid surge of environmental, social and governance investing, which considers the sale of tobacco products anathema. The benefit for being viewed as a corporate pariah is the company’s stock will most likely continue to remain cheap relative to the overall market.
It is no secret that cigarette smoking is on the decline in developed countries such as Europe and the United States. However, for the moment, the decrease in Imperial’s product volume is being offset to a degree by higher per-pack prices. To defray the persistent decline in traditional markets, Imperial, like other companies in the industry, has focused on countries in less developed regions such as Asia, South America and Africa, where cigarette smoking is still prevalent and will continue to remain so relative to developed markets.
The single most appealing aspect of the stock is its high dividend payout ratio, which should remain stable during the current tumultuous period of unprecedented high inflation and economic contraction. The charts below present historical data for dividend yield, payout ratio and dividends per share. As can be discerned, the dividends are amply covered by free cash flow as well as earnings per share. As corporate earnings slowly begin to contract, compare the 8.3% yield for Imperial to the S&P 500 ETF Trust (SPY, Financial), currently yielding a rather paltry1.5%.
As appealing as its generous dividend payments may be, investing in Imperial presents risks. One is the significant amount of debt on its balance sheet. Though the company is certainly not alone amongst its peers in the tobacco industry with high debt levels, management has made it a priority to reduce its long-term liabilities. For the first six months of the year, the company has reduced its debt-to-Ebitda ratio by approximately 0.2 for a current ratio close to 2.4.
Additionally, the company has been slow to develop next-generatoin products, which present long-term earnings growth issues. While Imperial’s last six months revenue for its NGP segment logged 8.7% revenue growth, traditional tobacco product revenue for all regions far surpassed those of the company’s smokeless categories.
There was considerable publicity surrounding the Federal Trade Commission’ recent rejection of Juul Labs Inc.’s e-cigarette vaping product. A note on the significance of the ruling is in order, not only for Imperial competitor Altria (MO, Financial), which owns a 35% stake in Juul, but also for the future viability of all NGPs.
It is important to note the FTC did not claim Juul’s vaping product itself was harmful or hazardous, but rather that the company did not present sufficient evidence to demonstrate its devices were safe. The fact the stock of British American Tobacco (BTI, Financial) declined less than 1% after the ruling should dispel any doubts concerning the prospects for vaping and non-nicotine oral products.
As such, British American might be a better bet for investors with a longer-term horizon. The company has invested considerable sums in non-combustible products, which, over time, unquestionably present more durable growth opportunities versus tobacco companies whose current product mix consists predominantly of combustible smoking offerings. Investors must accept British American’s lower 7.5% current yield for the enhanced prospect of greater earnings per share growth.
Investors may wish to note that competitor Altria’s current yield of 8.25% is approximately the same as Imperial’s, but its payout ratio is 142% versus 46.05% for Imperial. For investors, a question arises. In a high inflation, recessionary climate, which of the two companies’ dividend is more assured?
For enterprising investors who are seeking a short to intermediate term defensive strategy against rampaging inflation and a looming economic recession, I believe Imperial offers a suitable hedge.