A Solid Defensive Dividend Stock

I'm going to tell you about a large multinational stock that has a large presence outside of the U.S., posts a 4.3% dividend yield, made some strong acquisitions in the past year, has a long track record of profitability, and sells a non-cyclical product that should buoy the shares in a down market? Would you be interested?

Would you still be interested if I told you it was a tobacco company?

Ay, that's the rub
If you're a "socially responsible investor" (SRI), you've probably already clicked off the page, but for those of you who don't mind a little vice in your portfolio, I'll continue.

The company is U.K.-based Imperial Tobacco (NYSE: ITY). Outside of China, it's the fourth-largest tobacco manufacturer in the world, behind Altria's (NYSE: MO) Phillip Morris, British American Tobacco (NYSE: BTI), and Japan Tobacco.

Despite its large presence in the tobacco industry, Imperial Tobacco is relatively unknown to U.S. investors, with only 50,000 shares traded on the NYSE each day. Imperial Tobacco is most well-known for its Davidoff, West, and Lambert & Butler cigarette brands, which are some of the top cigarette brands outside of the U.S.

The company delivers its products to more than 130 countries. Its core markets historically have been the U.K., Germany, and Western Europe. Those markets are developed and consistent, and they're also very competitive, which makes it difficult to generate outsized growth.

To find greater growth opportunities outside of developed Europe, Imperial Tobacco made two acquisitions in the past year. One was U.S.-based Commonwealth Brands, which has about a 4% market share of the U.S. cigarette market and produces discount brands USA Gold and Sonoma. Not only does this acquisition give Imperial Tobacco an additional revenue stream in the U.S., but also allows it greater access to the Canadian and Mexican markets via NAFTA.

The second and more recent acquisition was Altadis SA of Madrid, which owns a 50% stake in the Cuban state tobacco monopoly, Habanos SA. Altadis' cigar brands are well known, with premium brands such as Cohiba, Montecristo, and Romeo y Julieta, and mass market brands Dutch Masters and Phillies.

Now that Fidel Castro has stepped down as leader of Cuba, the possibility of easing the trade embargo between the U.S. and Cuba becomes more plausible -- although still not altogether probable. This would boost Cuban cigar revenues in the U.S. and give Imperial Tobacco another strong revenue stream.

Cash crop
Effective cash management is one of Imperial Tobacco's strategic objectives, and it's been quite effective in this area, to the delight of the company's income-minded investors.

Imperial Tobacco increased its dividend by 12% in 2007 and has averaged 16% dividend growth over the past five years. According to its annual report, the company's dividend policy is "to increase dividends broadly in line with growth in adjusted earnings per share, with a payout ratio of around 50 per cent."

Those dividend payments appear to be sustainable. Imperial Tobacco generated more than $1.7 billion in free cash flow in 2007, with about $885 million paid out as common dividends.

Lawyers on the horizon?
But Imperial Tobacco isn't without its share of risks: for one, potential legal risks.

The tobacco industry has been rife with litigation problems, particularly Reynolds American (NYSE: RAI) and Phillip Morris in the U.S. But oddly enough, Imperial Tobacco has, to date, come away clean in this area. The company acknowledges some outstanding claims, but the company's directors don't believe the claims will have "an adverse effect upon the revenue, profit, or financial condition of the Group."

Investors should keep their eyes on Imperial's increasing presence in the U.S., however, and how this might affect its presently pristine litigious record.

Time to buy?
At first glance, Imperial Tobacco doesn't appear to be a traditional deep-value "steal;" it is trading around the industry average 17 times trailing earnings. On the other hand, it was trading at an average P/E of 23 times back in 2003, and shares have since risen 176%. The company's recent acquisitions, if successful, could justify the current price, if not a higher one.

Moreover, the stock's hefty 4.2% dividend and non-cyclical product could be a great way to survive a bear market.

If you're considering a purchase of Imperial Tobacco's ADR shares, be sure to use a limit order, as there's light volume on the stock and bid-ask spreads can be fairly significant.

For related Foolishness:

• Altria Continues Its Breakup
• British American Tobacco Should Light Up Returns