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Imperial Brands - On track, but blu investment a drag

Nicholas Hyett | 27 March 2019 | A A A
Imperial Brands - On track, but blu investment a drag

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No news or research item is a personal recommendation to deal. All investments can fall as well as rise in value so you could get back less than you invest.

Imperial Brands Group Ordinary 10p

Sell: 1,761.00 | Buy: 1,761.60 | Change -4.00 (-0.23%)
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Imperial is on track to deliver full year revenue growth at the upper end of guidance, for 1-4%, and earnings per share growth between 4-8%. Both Next Generation Products (NGP's) and Tobacco revenues grew during the period.

The shares were little moved in early trading.

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Our view

Any conversation about Imperial has to address two contradictory facts.

On the one hand the whole industry is seeing a steady decline in tobacco volumes. On the other, Imps continues to promise annual dividend increases of at least 10% "over the medium term".

That's possible thanks to steadily increasing prices and incessantly trimming operating costs.

Management reckon there are plenty of cost cutting opportunities left. Imperial has various regional brands with limited wider appeal. Migrating consumers off those to a select number of stronger Growth Brands significantly reduces cost and complexity.

Cost cutting can't continue forever though. And although we're generally supportive of the focus on margins over volumes, the decision to increase marketing spend to protect and develop the brand portfolio makes sense. Scale is the key to success in the tobacco industry, and as the smallest of the big-four tobacco giants, Imperial can ill-afford to lose ground to rivals.

Investment will be particularly important in the US. These brands played second fiddle under Reynolds' ownership, so turning them into powerful national players requires investment. Early signs have been promising, although a potential ban on menthol brands is bad news for the smaller Kool and Salem names.

However, investment will slow rather than reverse volume declines, making Imperial's vaping and heated tobacco products crucial to longer term success. A recent marketing splurge means things are heating up, but new regulation could yet send things up in smoke.

The balance sheet isn't yet in rude health, with significant work to be done in reducing debt. That could well hold back the shares, which already trade on a PE ratio of just 9.2, 20% below their long term average.

Nonetheless, Imperial generates bucket loads of cash, and can comfortably cover its dividend payments at present. With debt falling, interest payments are less burdensome than they once were, and the likely sale of European logistics business Logista will deliver a steady flow of cash.

In our view, Imperial's prospective yield of 7.9% means the shares look like an attractive income option. But what is one of the most generous dividend policies in the market cannot continue forever.

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Trading Update

Imperial is on course to deliver modest revenue growth from Tobacco, with growth weighted to the second half. Price remains a key driver of revenue growth, with volume trends slightly behind the second half of last year.

Within the NGP category, myblu is performing well, with significant investment in brand awareness initiatives. The group has built a strong market position in Europe and Japan, while the US has shown good year-on-year growth despite some uncertainty around incoming regulation.

Operating profits are expected to fall in the first half, as a slight increase in underlying profits from tobacco are offset by £100m investment in blu. First half earnings per share will also be impacted by the sale of Imperial's stake in Logista and the sale of the group's Other Tobacco Products business.

Underlying cash conversion remains strong, at around 90%, reflecting the timing of Logista cash flows and working capital investment in the UK related to Brexit.

Find out more about Imperial Brands shares including how to invest

The author holds shares in Imperial Brands.

Unless otherwise stated estimates, including prospective yields, are a consensus of analyst forecasts provided by Thomson Reuters. These estimates are not a reliable indicator of future performance. Yields are variable and not guaranteed. Investments rise and fall in value so investors could make a loss.

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.