Imperial has announced a change to its dividend policy. The 2019 dividend will grow by 10% (as expected) but beyond that the group has committed to a simple progressive policy, "growing annually from the current level".
Surplus cash will be used to invest in growth opportunities, particularly Next Generation Products, debt reduction and share buybacks (with up £200m of buybacks announced today).
Imperial's ongoing divestment programme is on course to generate proceeds of £2bn by May 2020, with the group targeting a net debt to EBITDA (earnings before interest, tax, depreciation and amortisation) ratio of 2-2.5 times.
The shares rose 1.6% in early trading.
Imperial's main attraction has long been the sizeable and growing dividend. However, impressive growth of 10% a year hasn't been enough to stop the shares falling more than 50% in since late 2016.
With the dividend yield for 2019 approaching 10.5%, management have clearly decided enough is enough. All being well payments to shareholders will continue to grow, but share buybacks and debt reduction have moved up the list of priorities.
This makes sense in our opinion. We believe a double digit dividend yield is more than most investors need or can reasonably expect in the current climate, and throwing more money at shareholders has failed to make the shares more attractive.
As the price to earnings ratio has fallen, currently at 7 times, buying back shares has become a cheaper option. Buyback's reduce the cost of future dividends and given Imperial's lowly rating could significantly improve earnings per share. Meanwhile debt reduction and growth investments will strengthen the group's long term prospects.
The change of capital allocation policy highlights an interesting feature of the wider tobacco industry. Increased investor focus on ethical investments seems to be hitting demand for the shares faster than it's turning Imperial's customers off smoking - the share price looks weak even when cash flows remain strong, and Imperial's whopping great yield is the result. That's an anomaly we expect to be around for some time.
Still, there's no getting away from the fact global tobacco volumes are shrinking, albeit slowly, and that's a challenge CEO Alison Cooper needs to address.
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.
But cost cutting can't prop up profits forever. The decision to increase marketing and development spending to protect and expand the portfolio is welcome. 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.
Investment will slow rather than reverse 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.
A net debt to EBITDA ratio of 2.9 times at the end of the last financial year means the balance sheet isn't yet in rude health either, with significant work to be done reducing debt.
Imperial's massive cash generation will be less focused on shareholder returns and more focused on profits and corporate housekeeping going forward. That may be no bad thing.
Half Year Results - 8 May 2019
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.
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%.
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.
The author holds shares in Imperial Brands.
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