At almost 9.5 per cent, the dividend yield attached to Imperial Brands' (IMB) shares puts the tobacco giant out in front of our 2019 Income Majors list. This may trigger a red flag for some investors, as such a high dividend yield can often be a signal that a company's capital structure is unsustainable. Perhaps mindful of the need to reset investor expectations and assuage fears, Imperial Brands this week said it will scrap its 10 per cent annual dividend growth policy, in favour of more modest – although still progressive – payouts.
As ever, it's a delicate balance. Imperial is, quite understandably, largely held for its income, although management said the changes are part of a wider review of capital allocation priorities. If distributions are to continue for the next decade, the group needs to up its investments in growth areas, specifically next-generation products (NGPs) and potential M&A opportunities to build its presence in that product line. Supporting this is the continued divestment programme, which is on track to bank around £2bn in proceeds from brand sales, including the cigars business, by May 2020.
In resetting the dividend policy, Imperial also said it would buy back up to £200m-worth of shares by the end of the 2019 calendar year, echoing the views of analysts who see the move as complementary to reducing leverage. That currently sits within the company's 2 to 2.5 times' net debt-to-cash profits ratio target range, though. Reducing gearing would also help to cut down on the interest Imperial Brands pays on its debt. At the most recent set of half-year results for the six months to March 2019, a reduction in debt servicing costs resulted in a 1.8p increase in earnings per share to 113p at constant currency. Interest cover also increased from 7.7 times cash profits to 8.6 times. The amount Imperial Brands paid in interest at £309m pales in comparison to £1.25bn paid out as dividends.
One of the biggest concerns surrounding tobacco stocks in recent years has been whether revenue from NGPs such as vapour can compensate over the long term for the steady decline in the volume of traditional combustible cigarettes sold. Encouragingly, NGP sales were up 245 per cent to £148m during the first half of the current financial year, with growth in Europe, the US, and Japan. The company invested £94m in NGPs during the period, particularly to increase brand awareness around its blu vapour product. Granted, that sales figure does not yet come close to the £2.39bn in sales generated by tobacco “asset brands”, but the company says it is aiming to generate between £250m and £1.5bn in revenue from NGPs by 2020 – with management bonuses linked to where they fall in this range. Fellow UK-listed rival British American Tobacco (BATS) is hoping for £5bn of sales from these products by 2023-24.