Imperial Brands: Dividend Resilience and NGP Growth in a Transitioning Market

The tobacco industry is undergoing a seismic shift, with declining traditional cigarette volumes and rising demand for next-generation products (NGPs) like e-cigarettes, heated tobacco, and oral nicotine. For Imperial Brands (LON:IMB), this transition presents both challenges and opportunities. Investors seeking steady dividends and valuation upside must weigh the company's robust capital returns against its debt-laden balance sheet and the structural decline of its core business. Here's why Imperial Brands remains a compelling—but nuanced—investment.

Dividend Sustainability: A Balancing Act

Imperial Brands has prioritized shareholder returns through dividends and buybacks, even as tobacco volumes decline. In 2024, the dividend per share rose 4.5% to £153.42p, supported by a 51.7% payout ratio relative to adjusted earnings. This leaves ample room for growth without overextending.

However, the first quarter of 2025 saw an eye-catching 78.5% jump in the interim dividend to £80.16p. This surge was partly due to a rephasing of dividends into four equal quarterly payments (up from two), which temporarily inflated the payout ratio to 129.3%. While this may raise eyebrows, management clarified that the full-year payout ratio should normalize to around 50%, aligning with historical trends.

The £1.25bn share buyback announced for 2025 adds to the allure, bringing total capital returns to £2.8bn this year. Over the next five years, the company aims for £10bn in cumulative returns, signaling confidence in cash flow generation.

Valuation: Undervalued, But For How Long?

Imperial Brands trades at a trailing P/E of 9.76 and a forward P/E of 9.01, both below industry averages. Its EV/EBITDA ratio of 8.31 also suggests bargain pricing, especially given its 12.37% free cash flow (FCF) yield—among the highest in the sector. With a 5.2% dividend yield and a shareholder yield (dividend + buyback) of 10.54%, the stock offers income investors a compelling value proposition.

Analysts see further upside: the 12-month consensus price target of £31.89 implies a 7.98% premium to current levels, while a discounted cash flow (DCF) model suggests the stock is undervalued by 42.4%. However, risks linger. The company's debt/equity ratio of 1.97 and an Altman Z-score of 1.38 (below the 3.0 bankruptcy threshold) highlight leverage risks. This contrasts with its Piotroski F-Score of 7/10, which acknowledges financial flexibility despite high debt.

Next-Generation Products: The Growth Engine

The real story lies in NGP adoption. Imperial's NGP revenue surged 26.4% in 2024 and 15.4% in Q1 2025, now accounting for 4% of total revenue. Key drivers include:
- Europe: The blu bar disposable e-cigarette and rechargeable kits are gaining traction.
- Americas: Zone oral nicotine pouches in the U.S. are expanding rapidly.
- AAACE (Africa, Asia, etc.): New iSenzia tea-based heated products are driving a 136.4% leap in regional NGP sales.

Management aims for double-digit NGP growth through 2030, targeting a material contribution to profits. While NGP margins remain lower than traditional tobacco, cost efficiencies and scale could improve profitability.

Risks to Consider

• Tobacco Volume Declines: A 4% drop in 2024 and 3.1% in Q1 2025 underscores the industry's structural headwinds.
• Debt Burden: The £10.9bn debt pile requires careful management, especially if NGP growth falters.
• Regulatory Risks: Stricter regulations on nicotine products could limit growth in key markets.

Investment Conclusion

Imperial Brands offers a rare combination of high yield, strong cash flow, and strategic growth in NGPs. While debt is a concern, the company's focus on disciplined capital allocation and shareholder returns reduces immediate distress risks. The stock's valuation metrics suggest it's undervalued, and the dividend's sustainability is underpinned by a conservative payout ratio.

For income-focused investors, the 5.2% yield and buyback program make IMB a buy. For growth investors, NGP adoption could propel valuation multiples higher if margins improve. However, those wary of leverage should monitor debt reduction progress.

In a sector in flux, Imperial Brands is navigating the transition better than many peers. The dividend remains a safe harbor, while NGP growth hints at a brighter future.

Final Take: Hold or accumulate Imperial Brands for dividend income and long-term NGP-driven growth, but keep a watchful eye on debt management.