Imperial Brands has released strong half year results and confirmed that it is on track to meet full year expectations. The shares fell by 0.5-1% in early morning trading.
On a constant currency basis Tobacco net revenue was up by 16.8%, adjusted operating profit rose by 19.5% and adjusted earnings per share grew by 20.4%. The first time-contribution from recently acquired US brands accounted for the majority of this growth. The integration of these brands is now largely complete and they are said to be performing strongly.
Total Group tobacco volumes fell by 3.1%, despite a 6.2% contribution from the US acquisition. On an organic basis volumes declined by 9.3%, of which a third related to the conflict in Iraq and cessation of trading in Syria.
Organic net revenue (excluding acquired US brands and Iraq/Syria) grew by 2.5% at constant currency; with a good performance from Growth markets (up 9.7%) offsetting a modest decline in Returns Markets (-0.5%).
The process of migrating consumers into a select number of stronger, higher quality brands continued in the period, as Growth and Specialist brands gained market share (+80 basis points) at the expense of 'Portfolio' brands (-50 basis points). The former now contribute 58.6% of tobacco net revenue.
Cash conversion was again strong, supporting a 10% increase in the interim dividend to 47.0p per share. However, adjusted net debt rose by 51% to £13.7bn as a result of the US acquisition.
Our view: Imperial's strategy of focusing on margins and cash flow, instead of chasing volume growth, is paying off.
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, it ought to be able to grow profits, pay off debt, and return further cash to shareholders. The prospective yield is 4.2%, and the company aims to grow the dividend by at least 10% per year over the medium term. Despite this, net debt is expected to fall by c. 20% over the next four years.
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