Recently renamed Imperial Brands has released an in-line Q1 trading update and confirmed it is on track to meet full year expectations. The shares rose by 0.5% in response to the news.
Tobacco net revenue grew by 16.6%; primarily driven by the acquisition of US brands last year, which are said to be performing strongly. Organic net revenue (excluding acquired US brands) grew by 2.0%, despite a 9.1% decline in volumes. Almost half of this volume decline was attributed to the conflict in Iraq and cessation of trading in Syria.
The group is aiming to improve the quality of revenue growth through prioritisation of Growth Brands and portfolio simplification. Growth Brands gained 100 basis points of market share with volumes up 0.4% (+7.3% excluding Iraq & Syria). Group market share fell by 40 basis points, however, reflecting declines in Portfolio Brands. Growth and Specialist Brands now account for 57% of tobacco net revenue.
The group expects to deliver incremental cost savings of £55m in FY16, and £300m of savings by September 2018. Operating cash conversion of over 90% is targeted this year, to fund debt reduction and at least 10% growth in the dividend.
Imperial Brands' Q1 results were severely impacted by the conflict in Iraq and cessation of trading in Syria, which led to a 9.1% decline in volumes. This headwind was well flagged by management at the full year stage and should ease from here. Despite these volumes declines, organic net revenue rose modestly, another illustration of the group's tremendous pricing power.
Brand migrations and cost savings are on track. Imperial has a large number of local and regional brands which have limited consumer appeal (Portfolio Brands). The group is in the process of migrating consumers into a select number of stronger, higher quality Growth Brands. This significantly reduces cost and complexity.
The integration of the US businesses is delivering against expectations. The deal with Reynolds American last year 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.
The industry is subject to numerous risks, 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.
But 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. The group is extremely cash generative so the yield of 4.4% for the current year looks well supported. The dividend is forecast to rise by 10% per year out to 2019, according to analyst consensus, with net debt expected to fall by c. 25% over this period.
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