Shares in tobacco company Imperial Brands (LSE: IMB) have delivered disappointing returns for investors over the past year. After a year-to-date decline of 14%, they’re currently valued at their lowest multiple on earnings for more than three years.
Out of favour
Sure, there are many reasons why the stock is currently out of favour. Cigarette stocks have clearly gone through a lot of changes lately, with growing regulatory challenges once again at the forefront of investors’ concerns.
Earlier this year, the US Food and Drug Administration announced a plan to limit nicotine content in cigarettes to non-addictive levels, in a sign of a toughening regulatory outlook that could significantly erode the industry’s long-term ability to drive revenue growth. This ties in closely with pre-existing concerns about the declining consumer base for tobacco products, exacerbating investors’ concerns about the decline in industry cigarette volumes.
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Long-term perspective
From a long-term viewpoint though, it’s hard to deny that shares in Imperial Brands are temptingly valued. Historically, the stock has reliably generated double-digit annual returns for shareholders over many years. Regulation and a shrinking consumer base are certainly not new things to the tobacco industry, and the company has successfully overcome similar challenges many times in the past.
Looking ahead, shareholder returns would probably moderate somewhat given the intensity of the industry headwinds, although I reckon this isn’t enough to justify Imperial Brand’s current low valuation.
Shares in Imperial Brands are now valued at just 11.3 times its expected earnings this year, meaning the company is trading at a significant discount to its sector peers. This doesn’t seem justified as takeover speculation is never too far away from the company. In the midst of intensifying competition, rumours are abound that Imperial could be a tempting takeover target given its low valuation.
And even if a bid fails to materialise, Imperial’s shareholders are handsomely paid to wait, with a prospective dividend yield of 6.1% this year.
Investor sentiment
Another FTSE 100 stock looking too cheap to ignore is defence outsourcing company Babcock International (LSE: BAB).
Shares in the company have fallen by 29% over the past year, as investor sentiment towards the broader outsourcing sector soured after a series of disappointing results from peers such as Mitie and Carillion. This was only made worse when Babcock itself warned that the UK government spending review could hit revenue growth at its land division next year.
Competitive advantage
On the upside however, the company’s focus on technology-intensive critical services gives it a competitive advantage over sector rivals, reducing competition risks and offering better growth opportunities ahead. Its recent results have also held up better than its peers, demonstrating Babcock’s relative strength in the embattled sector.
Underlying pre-tax profits in the six months to 30 September rose 4.9% to £239.5m, on revenue growth of 5.9%. Additionally, Babcock announced a 5.4% increase in its interim dividend to 6.85p, demonstrating the board’s confidence.
Looking ahead, the bottom line is expected to grow 3% this year, with City analysts pencilling in a further 4% increase for 2018/9. As such, the stock is valued at just 7.7 times its expected 2018/9 earnings.
