Neil Woodford adds to his Imperial Brands holding

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Neil Woodford released his October portfolio updates late last week. Within his Equity Income fund, Woodford added to several positions during the month, including Imperial Brands (LON: IMB) (IMB.L).

Here’s what Woodford Investment Management had to say about Imperial:

Imperial Brands detracted from performance, but it is difficult to explain why, other than the shares are currently out of favour. From a fundamental perspective, Imperial Brands continues to be a business which should deliver attractive and sustainable long-term growth, as it has done consistently throughout its history as a quoted, independent business. The chart below clearly illustrates that Imperial Brands has been a spectacularly good long-term investment, with share price performance being underpinned by strong and dependable growth in cash flow, earnings and dividend.

Obviously, as we all know, past performance is not necessarily a reliable guide to the future, but from our perspective, the investment case has not changed dramatically. What has changed recently, is the stock market’s level of interest in the investment case – it simply does not fit with the current market zeitgeist, and consequently, its share price has declined by almost 20% over the last twelve months. Interestingly, although the impact of cumulative compound growth makes it difficult to discern in the chart, there have only been two occasions since 1996 when the 12-month share price performance has been more negative than it is at the moment – during the dotcom bubble of 1999-2000 and during the financial crisis of 2008-09.

As a result of the recent share price performance, Imperial Brands has revisited valuation territory that we haven’t seen in many years. The shares currently yield more than 6% which, for such a cash generative business with a long track record of delivering consistent growth, just looks like the wrong price. On a 5-year rolling basis, the shares have never delivered a negative return – clear evidence that, although fundamentals may not always be rewarded over short time periods, over more sensible time frames, they are all that matter. We remain very attracted to the long-term fundamental investment case and added to the position at these very appealing and unjustified share price levels.”

Big dividend yield

I agree with Woodford’s logic here. The stock is clearly out of favour at present. It looks oversold, in my view.

The tobacco giant recently increased its dividend by 10% (for the ninth consecutive year), taking its payout to 170.7p per share. At the current share price, that’s a sizeable yield of 5.6%. The payout ratio was 64%, suggesting that Imperial can comfortably afford the dividend, and the group reaffirmed its policy of “growing dividends by at least 10 percent per year over the medium term.” Analysts expect payouts of 188.1p and 206.3p per share for 2018 and 2019.

Imperial has been a cash cow for investors in the past, and it looks to have cash cow potential going forward. On a P/E ratio of 11.1 the stock looks cheap. Like Woodford, I took the opportunity to add to my holding recently, taking advantage of the big dividend yield on offer.

Disclosure: Edward Sheldon, CFA owns shares in Imperial Brands. 

This article is provided for general information only and is not intended to be investment advice. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.

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