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Imperial Tobacco - "Another successful year"

Charles Huggins | 3 November 2015 | A A A
Imperial Tobacco -

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Imperial Brands Group Ordinary 10p

Sell: 1,551.00 | Buy: 1,552.50 | Change 10.50 (0.68%)
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Imperial Tobacco has delivered another solid set of full year results. Underlying volumes fell by 5.6%, over half of which was due to political disruption and security issues in Iraq and Syria. Nevertheless, tobacco net revenue still grew by 3.1%. Good cost control led to stronger margins and high single digit growth in profits at constant exchange rates (CER), enabling the full year dividend to be lifted by 10%. The shares were broadly flat in early morning trading.

Financial highlights (CER):

  • Underlying tobacco net revenue was up by 3%, or +5% excluding Iraq and Syria.
  • Total adjusted operating profit increased 7%; adjusted earnings per share grew 8%.
  • Cash conversion increased to 97%, up from 91% last year. Adjusted net debt increased by £4.6 billion to £11.6 billion due to the acquisition of assets from Reynolds American.

Business highlights (CER):

Net revenue in Returns Markets increased by 1%. Growth Markets net revenue was up 4.5% excluding Iraq and Syria; or down 2.5% with these markets included.

Growth Brands underlying volumes up 7%, net revenue up 12%, with market share growing by 110 basis points to 6.6%.

Underlying net revenue from Specialist Brands (which includes cigars and fine cut tobacco) was down by 0.7% as a result of Iraq and Syria; excluding this impact, underlying net revenue increased by 2.9%.

Cost optimisation programme remains on track to save £300 million per annum from September 2018, with incremental savings of £85m realised in FY 15.

The acquisition of US assets from Reynolds American was completed on 12 June and the enlarged business, ITG Brands, has made "excellent progress" against its commercial and integration plans.

Commenting on the outlook, the group said:

"We expect first quarter volumes will continue to reflect the situation in Iraq and Syria as well as a strong comparator quarter for volumes last year while first half revenue should benefit from stronger relative pricing. Overall, we are well placed to meet expectations for the coming year.

Challenges will persist in some markets but we have the assets and capabilities to further drive quality growth in this environment. We have the brands, the footprint and the people to make 2016 another successful year of value creation."

Our view:

Selling 6% less to your customers than you did last year wouldn't normally be considered an "impressive" performance. But the tobacco industry isn't like most industries. It is dominated by a few key players and the product it sells is highly addictive. This translates into tremendous pricing power and an ability to grow revenues even when volumes are falling. Add to this a relentless drive to cut costs and return cash to shareholders, and it is easy to see why tobacco has been one of the best performing sectors over the last 10-15 years.

The next decade may not be quite as good for investors as the last, with governments increasingly keen to crack down on tobacco consumption. The introduction of plain packaging in the UK and Ireland in mid-2016 (and its possible adoption in other EU markets in the longer term) is a potential threat; and taxes will only go one way. In theory, this will make it harder to keep pushing up prices.

Increasing political risk in Europe may explain Imperial's recent push into the USA. The deal with Reynolds American raises the proportion of US revenues from 7% to almost a quarter of the group total. Cigarette prices in the US are amongst the most affordable in the world. Because prices start from a much lower base, the group should have much more scope to raise prices to offset falling tobacco volumes.

If Imperial can keep up its cost and efficiency drive and successfully integrate the US assets, while returning cash to shareholders, then it ought to be capable of rewarding investors over the longer term. The shares currently yield around 4.4% (variable and not guaranteed), which is broadly in line with their historical average, but a premium to the FTSE All Share yield of 3.7%. The prospective price to earnings ratio (P/E) is 15x, a 25% premium to the long run average, but broadly in line with the wider market.

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 for more information.