FTSE 100 heavyweight Imperial Brands (LSE: IMB) is up 72% from its 11 April 12-month traded low of £16.77.
That said, this sort of price gain is no reason to avoid buying the stock, in my experience. It may be that the firm is simply worth more than it was before. Or it could be that the market is just playing catch-up with its true value.
In fact, there might be a lot more value in the stock than is reflected even in its higher price.
What could the stock’s fair value be?
The first part of my assessment of any stock price is looking at its key valuations compared to its peers.
On the price-to-earnings ratio, Imperial Brands currently trades at just 8.6 — bottom of its competitor group, which averages 20.4.
These firms include Altria at 8.7, Japan Tobacco at 15.9, British American Tobacco at 22.9, and Philip Morris at 34.1.
So, Imperial Brands’ share price looks very undervalued on this measure.
It also looks a bargain on the price-to-sales ratio too, presently trading at only 1.2 compared to a peer average of 4.
To work out what all this means in share price terms, I ran a discounted cash flow analysis. This highlights that the stock is 59% undervalued at its current £28.79 price.
Therefore, the fair value of the shares is £70.22. A variety of market forces could move it lower or higher than that, of course. But the DCF underlines to me the scale of the stock’s under-pricing highlighted in its key valuations.
How do its growth prospects look?
Imperial Brands’ earnings increased by an average 10.4% annually over the past five years. This outpaced the tobacco and nicotine sector’s 7.5% average yearly growth over the period.
And it is earnings growth that drives a company’s price and dividend over the long term.
For the next five years, at its 26 March Capital Markets Day, it forecast yearly low-single-digit tobacco net revenue growth. Over the same period, it projected double-digit net revenue growth for its Next Generation Products, centred on nicotine substitutes.
A risk here is that the intense competition in this business reduces Imperial Brands’ earnings. However, the firm expects annual operating profit growth of 3%-5% and earnings per share growth in the high single digits.
It also forecast free cash flow of £2.2bn-£3bn per annum over the five-year period. Free cash flow can also act as a major driver of growth.
Ongoing boost to shareholder rewards
I think the firm’s earnings and free cash flow should enable its share price to gradually close the gap to its fair value.
This process should be further helped by Imperial Brands’ pledge to conduct big share buybacks every year to 2030. These are also broadly supportive of stock price gains.
The firm additionally promised to continue its progressive dividend policy. These will grow annually at a rate that accounts for underlying business performance.
Currently, the stock yields 5.6%. However, analysts forecast this will rise to 6% in 2025, 6.2% in 2026 and 6.4% in 2027.
Given this and the share price implications of the new performance benchmarks, I think it is worth my while buying more of the stock, which I will do shortly.
This post was originally published on Motley Fool
