Dividend investment has always been a reliable method of building passive income streams. Now, as UK inflation reaches an alarming high of 5.4%, I am more determined than ever to find a long-term dividend stock to keep my portfolio stable during such tough times.
The share price of tobacco company Imperial Brands (LSE: IMB) has steadily risen to 1,757p, up 7% since the start of the year. The company is clearly recovering from its 15-year low in November 2020, at 1,219p. A look at its FY21 results suggests a reported 15% increase in operating profit and continued dedication to the company’s five-year plan has reinvigorated investor confidence. Imperial has an impressive 8% dividend yield and growing financial performance. I am certainly considering this tobacco giant as a long-term addition to my portfolio.
Dividend coverage
While such a high yield is enticing, a look at Imperial Brands’ coverage raises some concerns. Dividend coverage is calculated by dividing the company’s net income by the dividend paid to shareholders. It is an indication of how much risk a company is taking in paying its dividends.
The company’s dividend coverage decreased from 1.85 in FY20 to 1.78 in FY21. While this may not seem like a large drop, it is certainly distressing. Imperial Brands’ net income is less than twice as much as its dividend payout. This means a considerable reduction in yield could be necessary in order to protect overall financial health. The stability of its dividend yield may be at notable risk.
Compare this to Persimmon (LSE: PSN), which currently holds an impressively high dividend yield of 9.7%. A look at the company’s half-year results for FY21 shows a return of £750m to shareholders, which included top-up payments delivered in respect of previous dividend fluctuations. The company’s commitment to its dividends is supported by a consistent total equity of over £3bn throughout FY18-20. Imperial Brands is yet to deliver such persistent commitment to its payouts. Yet as the company begins to stabilise its financial health, it could potentially reach a strong level of consistency.
A stable financial performance
Despite coverage concerns, improvements in financial performance suggests Imperial Brands is prepared to deliver steady dividends in coming years.
Long-term increases in total revenue, from £27.6bn in FY16 to £32.5bn in FY20, show consistent financial growth. A more recent rise in operating profits, from £2.7bn in FY20 to £3.1bn in FY21, has also expanded opportunities for the company’s free cash flow. Indeed, with such cash flow set “to drive investment and shareholder returns”, my confidence in the tobacco giant’s ability to provide persistent dividends increases.
A 25% decrease in dividend payments from FY20-21 may be concerning. However, it is clear this reallocation of funds to debt reduction has been a successful managerial decision. The company has reduced its adjusted net debt by £1.7bn. This has created a far more stable position as it looks to meet its commitment to its five-year plan.
The tobacco company has achieved enormous success stabilising its overall financial position. With an 8% dividend yield now well-supported, and currently beating UK inflation rates, I will be looking to add Imperial Brand shares to my portfolio.
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Hamish Cassidy has no position in any of the shares mentioned. The Motley Fool UK has recommended Imperial Brands. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.
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