U.K. Tobacco Company Imperial Brands Is a Good Bet Against Inflation

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Stockholders have had a rough time this year, with surging inflation and fears of a recession. But there is a way to mitigate it: tobacco stock

Imperial Brands
.

The company (ticker: IMB.UK) offers potential total returns above 22% over the next 12 months, some analysts say. It markets cigarette brands including Winston, JPS, L&B, and Gauloises, and rolling paper Rizla. It is also developing next-generation products, or NGPs, which include vaping materials and oral nicotine.

Imperial Brands “is at the early stages of rebuilding a culture of boring reliability under its new CEO,” according to a report by RBC Capital Markets. In other words, the business is stable and not likely to produce unexpected shocks.

RBC sees the stock headed to 22 pounds sterling a share ($25.52), up 17% from its recent price of £18.95. On top of that, its annual dividend is projected at £1.40, or 7.4%. That hefty payout helps make the stock attractive during these turbulent times.

Garrett Nelson, an analyst at CFRA in Richmond, Va., says the category as a whole has historically “been one of the most recession-resistant industries.” Indeed, Imperial’s stock has rallied 17% this year. Over the same period, the

FTSE 100
index, which tracks the largest U.K.-listed stocks, and the

S&P 500
index, fell 3.2% and 17%, respectively.

The stock remains cheap, trading at 6.8 times forward earnings, which is lower than its five-year average forward price/earnings multiple of 7.5, according to Morningstar data.

At least part of the reason for the low P/E is that many institutions, especially those adhering to environmental, social, and corporate governance principles, refuse to buy tobacco shares. That practice, which is becoming more widespread, means their prices will likely remain cheap, relative to the broader market.

While cigarette smoking is waning in developed markets, such as the U.S. and Europe, the decline in sales volumes is partially being offset by higher unit prices and cost-cutting.

“Unit sales are declining in developed markets, in terms of the number of sticks [cigarettes] sold,” says Steve Clayton, a fund manager at U.K.-based HL Select. “Instead, the company is concentrating on less-developed markets.” These include South America, Africa, and Asia.

The NGP segment has shown some strength, with revenue growing 8.7% in the first half of the year, versus 0.1% for tobacco products. In all regions, the tobacco revenue dwarfs that produced by NGPs. The question is how fast the latter will grow and whether it will outpace the decline in the traditional tobacco business.

“If you are an investor in tobacco, you want to find a business that has got as durable as possible a cash flow coming out of the traditional business to support the growth in the new business,” Clayton says.

Imperial isn’t the only tobacco choice for investors in European stocks. Clayton points to

British American Tobacco

(BATS.U.K.) as an alternative that might suit longer-term investors looking for growth at the expense of dividends. British American markets brands such as Lucky Strike, Camel, and Dunhill, all well-known in the U.S.

And BATS is betting big on the future of new products. “BAT has a strong portfolio of next-generation products,” Clayton says.

The trade-off is a lower yield. British American has a projected dividend of 6.3%, which is less than Imperial’s. It also has a higher forward P/E of 9.5, versus imperials 6.8. “You get a slightly lower yield, but greater confidence in growth,” Clayton says.

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