Imperial Brands shares looks like a great buy at the moment
The share Imperial Brands (IMB) came onto my horizon in recent weeks. It's price is just 1870p, which is the lowest it has been since 2010. It's also got a dividend yield of a staggering 10.32%. (The dividend yield is the current annual dividend divided by the current share price).
Normally when the existing yield is that high, it's because the market thinks that the company is in trouble and will cut the next dividend, and hence they sell the share in advance. The drop in the share price compared to the existing dividend then shows up as a high dividend yield.
This rule of thumb (that when the dividend yield spikes due to falling share price, it indicates the company is in trouble) usually holds good, as we have seen with Vodafone, whose high yield caused by a crashing share price was followed by very poor results and a dividend cut.
However, it appears the crashing of Imperial Brands shares is down to something else: the investor Neil Woodford making distressed sales.
For those who don't know who Woodford is, he was a star performer at Invesco Perpetual who then set up his own fund. He then made the mistake of overloading his fund with small illiquid shares - he was supposed to have held only 10% of his fund in such shares but it rose to 18%. Because his fund was open, withdrawals by investors had to be funded by sales of his liquid holdings, and he was holding about $499 million of Imperial Brands shares, which are as liquid as you can get as they are a FTSE100 share. As withdrawals increased earlier this year, he sold more and more IMB shares to fund the withdrawals and the price of IMB crashed. He has now suspended withdrawals from his fund, as he is down to the illiquid holdings he can't sell.
What does this mean for Imperial Brands? It means that the share price is depressed due to an investor's distressed selling of assets rather than because there is anything wrong with the company.
A look at the accounts
However, all tobacco shares are down this year (the others are not as down as IMB, but still). This is down to dropping sales of cigarettes in the developed world, plus noises from the USA that they might regulate vaping. Imperial isn't that exposed to the USA, but the price fell on the news anyway, along with all the other tobacco shares.
However, due to the high amounts of tax on cigarettes, paradoxically the tobacco companies have great pricing power. Customers tend not to notice when the price of a pack is raised from say £20 to £21. It's already expensive, so what's an extra quid? So the tobacco companies are able to offset a drop in the volume of sticks sold with an increase in price.
Seeking alpha also pointed out that while the existing operating profit is flattish, the financing costs for Imperial Brands are dropping. See the following image they included in their piece:
The amount of interest they were paying in the six months to March 2019 fell 9.8% compared to the same period in 2018.
I then had a further look at their debt - Imperial Brands have helpfully listed all their bond issues in a handy pdf.
Here is a screenshot of the holdings that need to be rolled over in the next few years:
As you can see some big bond issues from a decade ago, with the high interest that was demanded a decade ago, are due to be rolled over. If they can roll over the $500 million bond with existing coupon of 7.75% with a new bond of 2.5% they pay 26.25 million less in interest each year. If they manage to roll over all their existing bonds at a lower coupon, their debt financing costs start to fall sharply. Add to this that the board of Imperial Brands has said that they intend to use some of their cashflow to pay down some of the debt entirely, and you can see where their profits are going to come from: reduced debt payments.
This means the dividend is safe, and even if the share price doesn't rise from here, at this yield, you will get your money back within ten years on dividends alone.
This looks like a very good buy to me, and on Friday I purchased some IMB shares.