Is the 7% dividend yield safe at Neil Woodford favourite Imperial Brands plc?

Roland Head wonders if Imperial Brands plc (LON:IMB) could run out of cash.

| More on:

The content of this article was relevant at the time of publishing. Circumstances change continuously and caution should therefore be exercised when relying upon any content contained within this article.

When investing, your capital is at risk. The value of your investments can go down as well as up and you may get back less than you put in.

Read More

The content of this article is provided for information purposes only and is not intended to be, nor does it constitute, any form of personal advice. Investments in a currency other than sterling are exposed to currency exchange risk. Currency exchange rates are constantly changing, which may affect the value of the investment in sterling terms. You could lose money in sterling even if the stock price rises in the currency of origin. Stocks listed on overseas exchanges may be subject to additional dealing and exchange rate charges, and may have other tax implications, and may not provide the same, or any, regulatory protection as in the UK.

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More.

FTSE 100 stalwart Imperial Brands (LSE: IMB) was the largest holding in fund manager Neil Woodford’s Equity Income Fund at the end of 2017.

But this defensive stock’s 28% decline over the last 12 months will have dented the value of many dividend portfolios.

Imperial shares now trade on a forecast P/E ratio of 10, with a prospective yield of 7.1%. If this payout is sustainable — as my fellow Fool Rupert Hargreaves believes — then this stock could be too cheap to ignore.

Should you invest £1,000 in Barclays right now?

When investing expert Mark Rogers has a stock tip, it can pay to listen. After all, the flagship Motley Fool Share Advisor newsletter he has run for nearly a decade has provided thousands of paying members with top stock recommendations from the UK and US markets. And right now, Mark thinks there are 6 standout stocks that investors should consider buying. Want to see if Barclays made the list?

See the 6 stocks

Why are the shares falling?

Imperial certainly faces some challenges. The group’s ‘stick equivalent’ volumes fell by 4.1% or 11.3bn last year, as declining consumption in mature markets outweighed growth elsewhere.

Excluding the benefit of shifting exchange rates, the revenue from tobacco sales fell by 2.6%, while adjusted earnings fell by 2.2% to 267p per share. Although the group is investing in new areas such as vaping and tobacco heating, these don’t yet generate a meaningful amount of profit.

Indeed, one potential concern is that while tobacco cigarettes are cheap to make and can be sold at very high profit margins, the products which replace them may be less profitable.

To combat falling levels of smoking, tobacco companies have been merging and combining. Doing this creates fewer, larger producers and cuts costs. This has been a fairly successful strategy, but acquisitions have left Imperial with net debt of £12.1bn.

This mountain of debt required interest payments of about £550m in each of the last two years. Some investors are now asking if this could threaten the safety of the dividend. To find out more, I’ve taken a closer look at the firm’s 2016 and 2017 accounts.

A cash machine?

One of the attractions of the tobacco business is that it doesn’t require much spending on research and development. The only time major investment is required is usually when an acquisition is made.

As a result, Imperial’s profits have been converted fairly consistently into free cash flow. This is what’s enabled the group to increase its dividend by 10% each year for the last nine years.

Looking at the group’s accounts for the last two years, I calculate that in 2016, free cash flow was £2,419m. Of this amount, £1,428m was paid out in dividends.

The situation got a little tighter in 2017, when free cash flow fell to £2,230m and the group paid out £1,577m in dividends.

My view

Free cash flow has fallen in each of the last two years, while dividend growth has been maintained at 10%. This has reduced the amount of cash available for debt reduction.

We don’t yet know how 2018 will turn out, but broker consensus forecasts suggest to me that surplus cash could fall again. The group’s adjusted net profit is expected to fall from £2,606m to £2,467m this year. If this decline is reflected in free cash flow, then the level of surplus cash available for debt reduction could shrink for a third consecutive year.

I think there’s a reasonable chance that this dividend will be maintained for the foreseeable future. But I think the high 7.1% yield indicates the falling quality of this payout. This share wouldn’t be at the top of my list of income buys.

Should you buy Barclays shares today?

Before you decide, please take a moment to review this first.

Because my colleague Mark Rogers – The Motley Fool UK’s Director of Investing – has released this special report.

It’s called ‘5 Stocks for Trying to Build Wealth After 50’.

And it’s yours, free.

Of course, the decade ahead looks hazardous. What with inflation recently hitting 40-year highs, a ‘cost of living crisis’ and threat of a new Cold War, knowing where to invest has never been trickier.

And yet, despite the UK stock market recently hitting a new all-time high, Mark and his team think many shares still trade at a substantial discount, offering savvy investors plenty of potential opportunities to strike.

That’s why now could be an ideal time to secure this valuable investment research.

Mark’s ‘Foolish’ analysts have scoured the markets low and high.

This special report reveals 5 of his favourite long-term ‘Buys’.

Please, don’t make any big decisions before seeing them.

Claim your free copy now

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Roland Head has no position in any of the shares mentioned. The 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.

More on Investing Articles

Electric cars charging in station
Investing Articles

Looking at Tesla stock? Consider this Warren Buffett-held EV rival instead

Tesla stock is one of the most popular investments in the UK right now. However, Edward Sheldon sees more appeal…

Read more »

Investing Articles

Up 18% in the past week, I think this FTSE 100 share could keep soaring!

While the FTSE 100's up 5.6% in the past week, this blue-chip share's risen much more sharply. Can it move…

Read more »

Concept of two young professional men looking at a screen in a technological data centre
Investing Articles

2 top growth stocks to consider buying for the next phase of the AI revolution

The artificial intelligence (AI) revolution is advancing rapidly on the application side, setting up these two growth stocks for more…

Read more »

Growth Shares

Will the Lloyds share price be a winner or loser from the tariffs turmoil?

Jon Smith explains both sides of the argument when trying to figure out if the Lloyds share price will move…

Read more »

Investing For Beginners

Aston Martin: is there a real risk the FTSE company goes bust?

Jon Smith notes the struggles over the past few years of an iconic car brand, but explains why his head…

Read more »

Growth Shares

2 crackerjack growth shares to consider buying as the dust settles

Jon Smith talks through a couple of growth shares that he feels represent good value for investors right now as…

Read more »

Mindful young woman breathing out with closed eyes, calming down in stressful situation, working on computer in modern kitchen.
Investing Articles

I’ve been investing in the stock market for 25 years. Here are 4 tips to navigate the current volatility

Investing during periods of extreme stock market volatility isn’t easy. Here, Edward Sheldon provides his top tips to get through…

Read more »

Investing Articles

£10,000 invested in Tesla shares a fortnight ago is now worth…

Despite extreme volatility, the value of a £10,000 investment in Tesla shares from a fortnight ago hasn’t changed much. That’s…

Read more »