UK Edition
Questor: Imperial Brands feels like a very uncomfortable stock to hold – which is why we will do so
Questor share tip: British American looked equally cursed this time last year and its shares have gained 37pc. The same could happen to Imps
Any stock to offer a dividend yield of more than 10pc carries a big risk warning, especially when the forecast price-to-earnings ratio is barely eight, as such figures usually mean it can be filed in the “too good to be true” category.
Throw in the ethical concerns that come with smoking, a mild profit warning and autumn’s parting of the ways with its chief executive and there are plenty of reasons to avoid Imperial Brands.
In some ways, this column wishes it had done so. Our initial analysis in April 2017 took a positive view at nearly £38 a share and it has been pretty much downhill all the way since then.
But that plump yield and lowly valuation price in a lot of the bad news and seem to gloss over how tobacco remains a highly profitable and cash generative business. Imperial’s cash flow still nicely covers the forecast £1.8bn annual dividend payment, even after capital investment, tax, interest and pension contributions.
Price increases help to compensate for falling volumes and the sale of the cigar business should further bolster the balance sheet.
Dangers still abound at Imperial Brands. Strong demand from investors for stocks that pass “environmental, social and governance” tests and an aversion towards names seen as less ethical could mean the shares simply languish (or worse); regulatory pressure remains intense; and price increases won’t be enough to compensate if volumes in America fall at a high-single-digit percentage rate.
As a result, this will feel like a very, very uncomfortable stock to hold. Yet British American Tobacco entered 2019 under a similar cloud and its shares have gained nearly 37pc in the past 12 months.
After a calamitous 2019 it may not take much by way of positive surprises to alter perceptions of Imperial Brands, especially as the change of chairman and chief executive frees the firm of an unnecessarily brave commitment to target double-digit percentage growth in the dividend. Even an unchanged divi would offer a fat yield and mean that investors were being paid to be patient.
Strong nerves will be required and anyone with ethical concerns will simply pass but the valuation is tempting and expectations are very low.
Questor says: hold
Ticker: IMB
Share price at close: £20.38½
Update: Morrisons
A combination of ordinary and special dividends worth more than 30p a share means that we have avoided losses on Morrisons in total return terms since our first look at the stock in October 2016. But it does feel as if clipping those payments is as good as it is going to get from the supermarket chain.
Its Christmas trading statement beat a low base of expectations, with a 1.7pc drop in like-for-like sales, while the wholesale business, which supplies goods via Amazon, convenience stores and petrol stations continued to contribute nicely.
- Sign up to our new City Intelligence newsletter for incisive comment on the day's biggest business stories
- Sign up to the Telegraph's Questor WhatsApp group for daily alerts and exclusive audio updates
- Read Questor’s rules of investment before you follow our tips
But selling groceries does not feel like a growth business, given the mature nature of the market, while relentless competition from discounters such as Aldi and Lidl means that it is unlikely to be a high-margin one either. That competition is not going away and it is slowly eating into Morrisons’ market share.
The good news is that the balance sheet is sound, with less than £1bn in net debt (although there is £1.3bn in lease liabilities) and plenty of asset backing from freehold property.
In addition, the £4.5bn market value is only a fraction above the first-half book value of £4.3bn.
Yet that valuation feels about right, on around 14.5 times earnings for 2020 with a yield of 3.6pc, a small premium and a small discount to the FTSE 100 respectively, given the limited growth prospects.
The prospects for capital gains therefore seem fairly modest, although income seekers may want to cling on.
Questor says: hold
Ticker: MRW
Share price at close: 189.25p
Russ Mould is investment director at AJ Bell, the stockbroker
Read the latest Questor column on telegraph.co.uk every Sunday, Tuesday, Wednesday, Thursday and Friday from 6am.