Imperial Brands Group (IMB) Ordinary 10p

Imperial Brands remains confident of meeting both half-year and full-year guidance. Excluding the effects of exchange rates, first-half underlying operating profit is expected to grow in the low single-digit range. Good tobacco performances in Europe and the Americas have more than offset a softer performance in other markets. Sales growth in Next Generation Products is expected to be in the mid-to-high teens, with operating losses reducing.

For the full year, net revenue is expected to grow in the low single-digit range, and operating profits in the mid-single digits. Growth is expected to be second half weighted, driven by tobacco price rises made in the first half.

Year-end debt levels are expected to land towards the bottom of the 2.0-2.5 range for net debt to underlying cash profit (EBITDA). £0.6bn of the £1.1bn share buyback program for this year has been completed so far. The remainder is expected to complete by the end of October.

The shares were trading flat following the announcement.

Our view

Imperial Brands generates most of its revenue from traditional cigarette labels such as Lambert & Butler, and John Player Special. Increasing regulatory pressure and changing consumer preferences towards healthier lifestyles, means this isn't an easy place to be. Industry volumes continuing to head downwards.

But the nature of selling an addictive product means Imperial's been able to put through big price increases to offset lower volumes. Combined with impressive cost savings, that means profits are holding up.

At the halfway mark in the financial year, Imperial looks well set to deliver more of the same in 2024. But tobacco companies can't fight the tide forever. If volume declines continue at this pace, growth in combustible sales won't be sustainable for long.

That's why the entire industry's jostling for position in the up-and-coming Next Generation Products (NGPs) market, including products like heated tobacco and vapes.

It's not been an easy start for Imperial. A more focused approach to the NGP portfolio is starting to bear fruit. But these products are still a relatively small part of the picture. It's too early to say if they can be a viable replacement for the shrinking tobacco business. First, we will need to see several years of high double-digit growth and demonstratable evidence of sustainable profit margins. Another risk to the success of NGPs is the increasing attention they are receiving from regulators.

This year, underlying net debt is expected to remain close to the lower end of Imperial’s target range of 2.0-2.5 times underlying cash profit (EBITDA). That's given Imperial the financial headroom to make generous payouts to shareholders. The shares are on a prospective yield of 9.2%. Forecasted dividend payments for the current financial year are more than 2 times covered by free cash flow. That also leaves enough to cover this year's proposed payouts under the renewed share buy-back programme. Please remember no shareholder returns are guaranteed.

Sitting just outside the big 5, rumours often swirl that Imperial will get bought out by one of the bigger players. This isn't imminent though - and we think competition regulators would prove a major hurdle given the already high degree of market concentration.

The other important thing to consider with tobacco stocks is that many institutional investors can't, or won't, invest in the sector. This may mean that the shares are rated lower than the outlook for the industry warrants, but it's hard to see attitudes changing and valuations recovering.

Environmental, social and governance (ESG) risk

The food and beverage industry tends to be medium-risk in terms of ESG though some segments like agriculture, tobacco and spirits fall into the high-risk category. Product governance is a key risk industry wide especially in areas with strict quality and safety requirements. Labour relations and supply chain management are also industry-wide risks, with other issues varying by sub-sector.

Imperial Brands’ overall management of ESG issues is strong according to data by Sustainalytics, but we have some concerns. The company has stressed its commitment to offer smokers a choice of potentially less harmful products. However, in 2023 next-gen products made up just over 3% of net revenue. The company is also involved in moderate controversies related to business ethics (including child labour and employee exploitation in the supply chain), marketing practices, and the social impact of its products.

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