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Imperial Brands - Currency boosts mask volume declines

Nicholas Hyett | 3 May 2017 | A A A
Imperial Brands - Currency boosts mask volume declines

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Imperial Brands Group Ordinary 10p

Sell: 1,728.20 | Buy: 1,728.80 | Change -25.80 (-1.47%)
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Sterling weakness meant headline first half numbers showed significant progress, with a 9.3% increase in tobacco net revenue and 7.9% increase in adjusted earnings per share. However, at constant currencies tobacco net revenue fell 5.5% and adjusted earnings per share was down 5.9%.

The interim dividend rose 10% to 51.7p per share, with the shares broadly flat following the announcement.

Our View

Imperial has historically focussed on margins and cash flow, instead of chasing volume growth. That's delivered a steady return for investors, with the group recently marking 9 consecutive years of 10%+ interim dividend growth. CEO Alison Cooper also restated the group's commitment to grow the dividend by 10% a year over the medium term. Analysts are forecasting a yield of 4.8% for the next financial year.

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 recently announced increase in marketing spend makes sense. The acquired US brands played second fiddle under Reynolds, so turning them into powerful national players requires money. Steadily declining share in other key markets, despite positive performances from Growth Brands, should also be addressed.

Early signs suggest the investment is delivering results. Growth brand market share is improving in many target geographies, while progress in the US, with the Winston and Kool brands, is particularly encouraging.

Of course the tobacco industry is subject to numerous risks, with governments increasingly keen to crack down on smoking. Plain packaging is a potential threat and taxes will only go up. In theory, that makes it harder to keep pushing up prices.

Nonetheless, Imperial's long term prospects remain bright. 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 further cash to shareholders.

Half year results

Against a background of falling tobacco volumes across the group, down 5.7% on the previous year, Imperial's Growth Brands saw volumes increase 3.2% and grow market share by 0.6 percentage points. The Growth and Specialist portfolios combined now account for 60.4% of group tobacco net revenues as brand migrations and SKU rationalisations continue to reduce the number of brands in the wider portfolio.

Thanks to this reduced complexity the group continues to deliver significant cost savings, with cost optimisation programmes now expected to deliver £130m of savings this year as opposed to the £90m announced in November.

Total adjusted operating profits of £1.7bn were up 6.3% on the year previously, although fell 7.6% at constant exchange rates. Cash conversion of 99.6% remained at very high levels, with free cash after dividend payments of £1.2bn.

Net Debt increased by £0.2bn over the quarter, to £14.2bn, as the £1.2bn debt reduction was more than offset by an adverse currency effect of £1.4bn.

Unless otherwise stated, all estimated figures, including prospective dividend yields, are taken from a consensus of analyst forecasts compiled by Thomson Reuters. These estimates should not be taken as a reliable indicator of future performance.

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.