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Imperial Brands - Continued progress, but challenges loom

George Salmon | 28 September 2017 | A A A
Imperial Brands - Continued progress, but challenges loom

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Imperial Brands Group Ordinary 10p

Sell: 3,067.00 | Buy: 3,068.00 | Change -36.00 (-1.16%)
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A brief trading update prior to the start of the group's close period on 1 October confirmed Imperial remains on track to meet earnings expectations for the full year, although the group did flag a 'particularly challenging industry environment'. The shares dipped 1.2% on the news.

Our view

Brand migrations and cost savings remain a key focus. Imperial has a large number of local and regional brands with limited consumer appeal (Portfolio Brands). It is migrating consumers off these to a select number of stronger, higher quality Growth Brands - significantly reducing cost and complexity.

We're generally supportive of Imperial's focus on margin over volume, however we also think that the decision to increase marketing spend makes sense. The acquired US brands played second fiddle under Reynolds, so turning them into powerful national players requires investment. It's encouraging to see early signs of progress here.

If it can keep a firm grip on costs and successfully integrate and build the US brands, it ought to be able to grow profits, pay off debt and return cash to shareholders.

Historically, Imperial has delivered a steady return for investors, and has chalked up 8 consecutive years of 10% plus dividend increases. The group is looking to maintain this rate of growth over the medium term. With a prospective yield of 5.6% and substantial free cash flow, the group looks like an attractive income option in our view. Always remember however, that there are no guarantees as far as dividend growth targets are concerned.

Of course, the tobacco industry is subject to numerous risks, with government intervention usually not far away. Indeed, the US regulator's decision to target reducing nicotine content to 'non-addictive' levels presents another challenge to go with longer-running headwinds like the increased adoption of plain packaging and the upwards trajectory of taxation.

Longer-term, there's also the risk of new technologies rising up to disrupt traditional cigarette sales. Imperial has a strong brand in vapour, but relatively little in the heat-not-burn sphere. This, and its lower growth end markets, may explain why the shares trade on a price to earnings ratio of 11.7. By comparison, British American Tobacco, which has a more established presence in heat-not-burn technology and a greater exposure to emerging markets, trades on 15.4 times expected earnings.

Trading update:

Looking ahead to full year results due on 7 November, Imperial expects to deliver strong growth in reported revenues and earnings. Results on a constant currency basis are set to be impacted by this year's significant additional investment, although the group says this spending has helped to deliver a stronger second half performance. It has reported market share gains in priority markets and continued outperformance from its 'Growth' brands.

Imperial continues to build up its 'Next Generation Products', which offer alternatives to traditional tobacco products. The group is gearing up to further extend its footprint with new launches, and is focused on improving consumer experience and building the flagship 'blu' brand.

During the period, Imperial sold down its holding in Spanish distributor Logista, with the proceeds being used to buy-back shares and reduce debt. The group also confirmed it is working to create 'a sustainable future' for the UK's biggest tobacco supplier, wholesaler Palmer & Harvey.

Unless otherwise stated estimates, including prospective yields, are a consensus of analyst forecasts provided by Thomson Reuters. These estimates are not a reliable indicator of future performance. Yields are variable and not guaranteed. Investments rise and fall in value so investors could make a loss.

This article is not advice or a recommendation to buy, sell or hold any investment. No view is given on the present or future value or price of any investment, and investors should form their own view on any proposed investment. This article has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is considered a marketing communication. Non-independent research is not subject to FCA rules prohibiting dealing ahead of research, however HL has put controls in place (including dealing restrictions, physical and information barriers) to manage potential conflicts of interest presented by such dealing. Please see our full non-independent research disclosure for more information.