Buy Imperial Brands for generous dividend

Vaporisers are a key focus for Imperial under the brand ‘blu’ and, according to management, an increasing rate of pod repurchasing reflects a “really positive response from smokers, vapers and retailers” – a key component in getting customers to change their nicotine habits. Vaping is believed to be a better way to deliver nicotine, as the FDA believes the biggest harm from smoking is the result of inhaled particles from burning material, and so future regulation will look to discourage smokers from combustible products.

Imperial Brands’ management has said it believes the market for vapes, one of the most promising areas of NGPs, is currently worth around $8bn, but could be worth between $30bn and $50bn by 2025. Revenue from vapour has gained momentum during the current financial year. Management thinks near-term compound annual revenue growth could be anything between 35 per cent and 150 per cent – the upper end of which would result in £1.5bn of NGP revenue in 2020. NGPs are expected to become profitable at the end of the current financial year, with margins continuing to build thereafter.

NGPs aren’t the only way Imperial Brands is getting creative with its revenue streams. Through its Imperial Brands Ventures subsidiary, the company recently bought a stake in Oxford Cannabinoid Technologies (OCT), which focuses on the medical uses of cannabis. Funding from Imperial Brands will help the company research how cannabinoids can be used to treat pain, inflammation and gastrointestinal issues. Legalisation of cannabis is gaining traction internationally, with the drug legal across Canada as of this month. Nine US states allow its use recreationally, and 30 have legalised medical use.

For now, more than 90 per cent of group operating profit still comes from tobacco. Cigarette volumes continue to fall, but for Imperial Brands the decline is at a slower rate than that of the wider industry. So far this financial year, this decline has been significantly offset by a better tobacco price. The company has been investing in its premium brands, while selling off some lower-level tobacco brands in an effort to overhaul its portfolio and generate around £2bn, part of which will go into NGP development.

Imperial Brands is committed to increasing the dividend by at least 10 per cent each year over the medium term, and the dividend has only ever gone up since the company was spun out of Hanson and listed on the FTSE 100 in 1997. The risk to Imperial Brands, and to its dividend policy, is that NGPs cannot make up for falling cigarette sales over the long term. 

Consistent cash conversion has so far allowed Imperial Brands to keep up with its dividend promises. During the year to September 2018 management expects to report an adjusted operating cash conversion rate of 95 per cent. In the year to September 2018, broker Liberum expects dividend payments to total £1.63bn, covered by £2.52bn of free cash flows.