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Imperial Brands - Questions about full year targets

Nicholas Hyett | 8 May 2019 | A A A
Imperial Brands - Questions about full year targets

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Imperial Brands Group Ordinary 10p

Sell: 1,402.00 | Buy: 1,403.00 | Change 7.00 (0.50%)
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Half year net revenue increased 2.5% to £3.7bn, driven by strong growth in Next Generation Products (NGPs), but below Imperial's guidance for the full year.

Underlying adjusted operating profit rose 4.9% to £1.6bn - although ongoing investment in NGPs and the absence of last year's asset disposals meant reported profits fell 1.8%.

The interim dividend rose 10% to 62.56p.

The shares fell 4.2% following the announcement.

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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 remains committed to annual dividend increases of at least 10% in the "medium term".

CEO Alison Cooper has been able to square the circle by 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 and development spending to protect and expand 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.

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. That might be behind the group's incredibly wide range for NGP revenues - anywhere from £250m to £1.5bn by 2020.

Conventional nicotine products are in the firing line as well, with US regulators looking to crackdown on menthol and nicotine-levels. Not ideal given Imperial's only just started growing market share across the pond.

The balance sheet isn't yet in rude health either, 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 8.4, almost 30% below their long term average.

Historically Imperial has generated bucket loads of cash, and that's allowed it to sustain one of the most generous dividend policies on the market.

However, the first half of this year saw operating cash flows shrink dramatically - and although management expect a significant improvement in the second half it will have sharpened investors focus on Imperial's prospective yield of 8.8%.

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Half Year Results

Tobacco volumes declined by 6.9% year-on-year, equivalent to 8.4bn cigarettes. That reflects unfavourable shipment timings, plus underlying declines across the industry. However, volume headwinds were offset by improvements in pricing/mix.

Growth Brand revenues grew strongly in the period, with blu and Davidoff both performing well, rising 5.9% to £1.8bn. Specialist Brands saw revenue increase 10.6% to £602m. Together the two categories now account for 65.3% of revenues, helping offset a weaker performance in Portfolio Brands - which saw revenues fall 5.2%.

NGPs delivered revenue growth of 245% to £148m, driven by expansion in Europe, Japan and the US. Investment in these products totalled £94m during the period. Imperial continues to expect NGP revenues of between £250m and £1.5bn by 2020.

Imperial is on course to deliver £300m of cost savings by September 2020, but this year's savings will be lower than previously thought, at £60m.

Working capital movements, largely due to timing, meant cash conversion deteriorated significantly year-on-year. As a result underlying net debt increased by £0.2bn, to £13bn. However, cash conversion is expected to improve in the second half.

Imperial expects a stronger second half, and remains on track to meet full year expectations. The disposal programme is continuing as planned.

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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.