While defensive stocks have come under pressure since Donald Trump’s US election win, many still trade at relatively high multiples. Indeed, a quick scan across a watchlist of defensive names reveals that several trade at forward looking P/E ratios of at least 20 times next year’s earnings. However, two defensive stocks stand out as being cheaper than their peers at the moment. Should you take advantage of recent share price weakness and buy now?
Imperial Brands
Three months ago, Imperial Brands’ (LSE: IMB) shares were hot property. Investors were flocking to defensive stocks post-Brexit and the tobacco giant had seen its share price rise around 25% over 12 months, pushing its trailing P/E ratio to approximately 20 and its yield to just 3.7%.
However fast-forward to today, and Imperial now trades around 16% lower than it did mid-August after recent results weren’t received well by the market and investors have moved away from defensive companies on the back of Trump-related inflation expectations.
Imperial explained in its 8 November final results that it will commit to reinvestment of £300m for “selected quality growth opportunities” in FY2017, in the hope that this will support revenue growth over the medium term. At the same time, the company aims to reduce annual costs by £300m by 2020. Imperial believes these strategies will help to generate 4%-8% earnings per share growth annually, however the dramatic drop in the share price suggests the market is unconvinced these measures will alter the growth profile of the company.
Buying high quality dividend stocks when they’re out of favour can reap rewards over the long term, and there are several reasons I believe the recent fall at Imperial has created an opportunity. First, from a technical analysis perspective, Imperial’s relative strength indicator (RSI) suggests that the stock is way oversold. Second, with analysts forecasting earnings of 276p for FY2017, Imperial’s forecast P/E ratio is just 12.5, a level well below many of its defensive peers. Third, after paying out 155p in dividends for FY2016, Imperial’s dividend yield has now been boosted to 4.5% and this is forecast to grow to 4.9% next year. Furthermore, Imperial has increased its dividend by 10% for eight consecutive years and the company stated in its recent results that it “remains committed to this level of increase over the medium term.”
For long-term investors looking to put the power of compounding to work, I believe Imperial Brand’s share price fall has created a great buying opportunity.
SSE
Another defensive stock that appears to offer value right now is utility giant SSE (LSE: SSE).
While recent half-year results weren’t particularly strong with adjusted earnings per share (EPS) falling 25.5%, the company did give full year EPS guidance of “at least 120p,” meaning that at the current share price, SSE trades on a forecast P/E ratio of just 12. This is cheap relative to other defensive stocks and utility peers National Grid (14.5) and United Utilities (19.5).
Importantly for income investors, SSE increased its interim dividend by 1.9% and noted that it remains on course to increase dividends in line with RPI inflation, while keeping dividend coverage of between 1.2 to 1.4 times.
With the recent share price weakness boosting SSE’s forecast yield to a huge 6.3%, SSE looks like a great stock for income seekers, in my opinion.
