Why high inflation and an uncertain economic outlook make Imperial Brands and Severn Trent more appealing

An uncertain economic outlook could prompt increasing demand among investors for defensive stocks such as Imperial Brands (LON: IMB) and Severn Trent (LON: SVT). Both companies are less dependent on the economy’s performance than many of their FTSE 350 index peers. As such, they may offer greater resilience and less risk during a potentially turbulent period for the economy.

In addition, both stocks offer relatively attractive income prospects. Their capacity to raise dividends at a brisk pace could mark them out as appealing during a period of high inflation. As a result, they could generate strong total returns over the medium term.

Imperial Brands

Imperial Brands’ share price has risen by 10% in the past year, which represents an outperformance of 3% of the FTSE 100 index. However, it continues to offer one of the highest yields in the index due in part to its disappointing capital returns in previous years. Indeed, at the present time, it has a dividend yield of 8.5% versus 3.3% for the FTSE 100.

The firm’s decision to exit its operations in Russia meant that it reduced financial guidance for the current year. However, its latest trading update showed that it is making progress in areas such as growing market share in key markets and conducting trials of next-generation products. Although it is somewhat behind sector peers in terms of adapting to evolving regulatory and consumer views on nicotine products, it nevertheless has the capacity to fix this over the long run.

In the short term, the firm’s ability to raise prices could make it appealing to investors. Relatively inelastic demand for tobacco products means that Imperial Brands could offer a higher degree of protection from rampant inflation. Moreover, robust demand within the tobacco industry means that it may be less affected by the prospect of a recession than many other large-cap shares.

Trading on an adjusted price-earnings ratio of under 7, the stock appears to offer a wide margin of safety. It could prove to be a sound risk/reward opportunity given current, and expected, macroeconomic conditions.

Severn Trent

Water services business Severn Trent also offers defensive appeal amid an uncertain economic and geopolitical outlook. Demand for water is unlikely to change materially even during periods of economic decline. And, while the cost of living crisis could cause an increase in bad debt charges should consumers struggle to pay their bills, they declined to 2.2% of household revenue in the first half of the year from 3% at the end of the previous full year.

Severn Trent’s income appeal is also high. Although the stock has a somewhat modest yield of 3.2%, its dividend growth potential could become increasingly attractive. It is aiming to increase shareholder payouts by the same rate as inflation over the coming years. This could mean the firm’s shares offer a degree of protection against continued high inflation, which recently reached its highest level since 1992.

Of course, the company is unlikely to offer rapid earnings growth over the medium term should the global economy grow at a brisk pace. However, its defensive characteristics and income appeal mean it remains a sound investment prospect at the present time.