As income stocks go, Imperial Brands (LSE: IMB) is right up there with the best, in my opinion. Here’s why.
Falling shares
Despite Imperial being one of the world’s largest tobacco businesses, its shares haven’t fared well in recent years.
Over a 12-month period, they’re down 4% from 2,022p at this time last year, to current levels of 1,931p.
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Over a five-year period, the shares are down 24% from 2,559p to current levels. Looking back even further, they’ve slipped 51% from 4,053p in the summer of 2016, to current levels.
Surely a declining share price is a sign of a troubled business? In this case, I don’t think it is. I reckon the rise of ESG investing, coupled with volatility, and developed countries like the UK putting more effort into non-smoking initiatives, has hurt the share price.
Dividends galore!
Before I dive into my bull case, there are risks that could hurt longer-term payouts. As I touched upon earlier, ESG investing has risen in popularity and tobacco stocks like Imperial have been affected. The ill-effects of smoking are hard to ignore, therefore ethical investors are ignoring the stocks and seeking passive income and growth elsewhere.
Next, due to these ill-effects, developed nations are working hard to curb smoking numbers. For example in the UK, the looming spectre of government reforms could hurt smoking numbers in the years to come. This could hurt Imperial’s performance and returns.
Moving to the bull case then, I’m not overly worried about the second risk I mentioned a moment ago. This is for two reasons. Firstly, changing the law and pushing initiatives to massively reduce smoking numbers could take years, even decades. Secondly, Imperial and other tobacco companies make most of their money in developing countries, where smoking rules and regulations are much more relaxed. Personally, I have no qualms with buying tobacco stock from an ethical perspective.
Plus, Imperial has recognised the need to move with the times and offer non-tobacco alternatives, what it dubs Next Generation Products, or NGPs. This area has done well in recent times and could continue to grow. One risk to note here is that the firm has pumped significant amounts of money into this. Continued investment could hurt payout levels, especially if the NGP’s don’t provide the same level of return as cigarettes.
Tobacco firms have a long history of high cash generation and generous investor rewards. Although I understand the past is not a guarantee of the future, I find it hard to ignore a dividend yield of 7.5%, which looks well covered. In addition to this, the falling share price has made the shares very cheap on a price-to-earnings ratio of just seven.
My verdict
I can understand why ESG investing and increased scrutiny around newer non-tobacco products has hurt the shares. Nevertheless, I reckon Imperial Brands should and could reward investors handsomely for years to come. In the very long term future, things could get trickier, but I’m talking a few decades, barring a major shift in regulatory momentum very soon.
I’d buy Imperial shares for passive income in a heartbeat when I’m next able to.
