Tobacco shares are well-known as often benefitting from high cash flows that can support substantial dividends. Indeed, this week, Imperial Brands (LSE: IMB) raised its dividend. If I wanted to increase my exposure to tobacco stocks today, would I be better buying Imperial Brands shares or those of rival British American Tobacco (LSE: BATS)?
High-yield opportunity
Both shares offer an attractive dividend yield. Imperial Brands shares yield 7.8%, while British American offers 9.1%.
Imperial cut its dividend three years ago, whereas British American has raised its payout annually for decades.
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I was pleased to see that Imperial grew its dividend by 4% this week. That is markedly higher than its increases over the past several years. British American’s most recent dividend increase was higher still, at 6%.
So when it comes to dividends, I think British American comes out better.
Long-term business prospects
But dividends are never guaranteed. A key risk to tobacco companies is that fewer and fewer people smoke in many markets, hurting cigarette sales and profits.
Both British American Tobacco and Imperial Brands shares have fallen over the past five years, by 10% and 26% respectively.
I think those falls partly reflect investor concern about this risk. However, the much larger fall in Imperial Brands shares could also reflect concerns about how the firms hope to keep generating cash flows to fund their dividends.
Imperial has scaled back its non-cigarette ambitions for now and is trying to build cigarette market share in key countries. British American also remains heavily reliant on cigarette sales. But it is aggressively growing its non-cigarette business. It expects it to break even next year.
In the short term, I like Imperial’s strategy that keeps its focus on the cash cow. Longer term though, British American seems better placed for ongoing growth. Indeed, Imperial’s revenue last year actually fell a little. In its most recent results (for the first half only), British American reported revenue growth compared to the prior year period of over 4%.
Again, on this metric, I fancy British American as the better buy.
Comparing the valuations
What about the valuations of the two companies? After all, successful investing does not only mean buying into the right businesses, but also doing so at a good price.
Imperial Brands shares trade on a price-to-earnings ratio of 7. That already looks fairly cheap to me. But British American is even lower, at 6.
Those ratios rely on earnings though, and those could fall. Not only are both businesses battling falling cigarette demand, they also both have substantial debt. That could eat into earnings.
For now though, from a valuation perspective, I again fancy British American Tobacco more than Imperial Brands shares.
Voting with my feet
I have put my money where my mouth is, reckoning British American Tobacco is the better buy of the pair right now, at least for me.
I no longer own Imperial Brands shares, which I once did. But I have topped up my British American holding this year.
