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Shares in the FTSE 100’s Imperial Brands (LSE: IMB) have dropped 10% from their £31.79 one-year traded high.
Such a drop could indicate that the underlying business is fundamentally worth less than it was before. Or it could signal a terrific bargain-buying opportunity for investors whose portfolios it suits.
How does the business look?
A risk for it is that its transition to nicotine replacement products from tobacco ones stalls for some reason. This would allow its competitors doing the same thing to steal the advantage.
However, its H1 2025 results announced on 14 May looked solid enough to me. Adjusted tobacco and next-generation product (NGP, mainly nicotine replacements) revenue was up 3.2% year on year to £3.664bn. Adjusted operating profit increased 1.8% to £1.652bn.
Revenue is the total income made by a firm, while profit (or ‘earnings’) is what remains after expenses are deducted. And it is profit that powers any firm’s share price and dividends over the long term.
Indeed, earnings per share (EPS) jumped 6% to £123.9m, while the dividend for the half soared by 78.5% to 80.16p.
The firm reiterated its double-digit compound annual growth rate (CAGR) for NGP revenue to 2030. Additionally, it projects low-single-digit CAGR for tobacco net revenue over the same period. It also expects annual operating profit growth of 3%-5% and EPS growth in the high single digits.
The forecast for annual free cash flow from now to the end of 2030 is an extremely robust £2.2bn-£3bn. This sort of expansion can be a potent driver for growth in itself.
Undervalued?
The first part of my assessment of the stock’s value is to compare its key valuations with its competitors.
Its 1.2 price-to-sales ratio is very undervalued against its peers’ average of 1.2 – and it is bottom of the group.
The companies consist of Japan Tobacco at 2.3, British American Tobacco at 3, Altria Group at 5, and Philip Morris at 7.3.
It is also very undervalued – and bottom of the group – on its 8.9 price-to-earnings ratio compared to its competitors’ average of 22.1
The second part of my assessment establishes where its share price should be, based on cash flow forecasts for the underlying business.
This is done through a discounted cash flow analysis, which for Imperial Brands shows it is 44% undervalued now.
Therefore, the fair value for the shares is £50.84 compared to the present £28.47.
Dividend yield forecasts
In 2024, the firm paid a dividend of 153.42p, which gives a current yield of 5.4%.
Analysts project that the dividend will increase to 163.3p this year, 171.7p next year, and 180.9p in 2027.
This would generate respective yields on the present share price of 5.7%, 6%, and 6.3%.
Based on the current 5.4% yield, investors considering a holding of £11,000 (the average UK savings) would make £7,853 after 10 years. After 30 years on the same basis – which also includes ‘dividend compounding’ – this would rise to £44,382.
Including the £11,000 initial stake, the holding would be worth £55,382 by then. This would generate an annual dividend yield of £2,991 by that stage.
None of that is guaranteed, of course and share prices and dividends can go down as well as up. But given this, and its extreme undervaluation, I will be buying more of the shares very soon.
