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Imperial Brands - dividend cut by one third

Sophie Lund-Yates, Equity Analyst | 19 May 2020 | A A A
Imperial Brands - dividend cut by one third

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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: 1,418.50 | Buy: 1,420.00 | Change -7.00 (-0.49%)
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Imperial Brands has cut its dividend by a third to prioritise debt reduction. The new quarterly dividend will be 41.7p per share, implying an annual dividend of 137.7p for 2020.

Net revenue fell 0.9% to £3.6bn, excluding the impact of exchange rates, and adjusted operating profit fell 7.7% to £1.5bn. Next Generation Product (NGP) revenue fell 43.2% to £83m, reflecting customers' lower inventory levels, and reduced investment in response to underwhelming sales. The group wrote down the value of the NGP portfolio by £95m. Excluding these write downs, adjusted operating profit for the group fell 1.8%.

Management estimates both revenue and operating profit were boosted by 1% thanks to inventory building in response to COVID-19, and that this will unwind in the second half.

The shares fell 6.9% following the news.

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Our view

Tobacco is a defensive sector because demand isn't very sensitive to economic conditions. This has broadly held during the COVID-19 pandemic, but Imperial is still expecting a small fall in profit because of the virus.

We understand tobacco shares aren't for everyone, and global tobacco volumes have been falling for decades.

But smokers' willingness to pay ever higher prices meant tobacco giants had managed to protect their margins and grow dividends even as the smoking population dwindles. However, Imperial has decided to cut its dividend to focus on debt reduction. The cut has come before the new CEO, Stefan Bomhard, starts his tenure on 1 July 2020. This gives him greater flexibility and means his first act as the new boss won't be to slash the payout to shareholders. The new dividend implies a prospective yield of 8.3% for the current financial year.

At the last count Imperial was carrying about 3 times net debt to underlying cash profits, which management wants to bring down to 2-2.5 times by the end of 2022. The sale of the Premium Cigar business will help here, and we understand the group wants to simplify its operations, but still think Imperial's losing an attractive asset.

The question is whether growth can be achieved going forwards, which will be essential if the dividend is to grow again. That depends on price increases offsetting the expected declines in cigarette volumes, and the inability of governments to capture these increases through higher tobacco duties.

Next Generation Products (NGPs) offer a potential path to growth, and Imperial has primarily invested in vapour via blu. Recent health scares and legislation in the US have severely knocked progress though, and while we think NGPs have a future it doesn't look like growth will be anywhere near as fast as some were hoping. This has reduced the value of Imperial's existing investments, and caused it to scale back future funding. It remains to be seen what line the incoming CEO will take.

Finally, as Imperial is the smallest of the four tobacco giants there's a possibility it will get bought out by one of the bigger players. This isn't proposed at the moment though - and if it is, competition regulators may prove a major hurdle given current market concentration.

Many institutional investors can't or won't invest in tobacco stocks. This may mean that the shares are rated lower than the outlook for the industry really warrants, but it's hard to see attitudes changing and valuations recovering soon. This means the investment case is built around the dividend yield, which is substantial even after the cut. Remember, dividends are never guaranteed.

However, it may be the case that the tobacconists can't keep squeezing more money out of an ever smaller population of smokers. If so, the dividend stream is bound to dry up eventually - and in that light the valuation starts to look less compelling.

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Half year results (figures are underlying)

Total tobacco volumes fell 0.5% to 114.6bn stick equivalents. The group grew overall market share by 0.4 percentage points to 13.6%, including gains in seven out of ten priority markets. Tobacco revenue grew 0.9% to £3.5bn.

In Europe tobacco net revenue rose 0.5% to £1.6bn, but NGP revenue fell 56.2% to £30m. Total revenue fell 2% as a result. Market share grew in Spain and Italy, and sales trends improved in the UK and France. Operating profit for the division fell 6.7% to £706m, reflecting lower NGP sales, higher provisions for slow-moving NGP inventory and the timing of marketing expenses.

In the Americas total revenue fell 2.8% to £1.1bn, reflecting a 50.8% fall in NGP revenue to £30m and flat tobacco net revenue. Operating profit fell 11.8% to £390m, driven by losses in NGPs which more than offset profit growth in tobacco.

Africa, Asia and Australasia net revenue rose 3.8% to £882m, reflecting 2.9% growth in tobacco net revenue to £859m and 57.1% growth in NGPs to £23m. Operating profit fell 7.9% to £287m, reflecting investment behind Pulze, a heated tobacco NGP in Japan.

Distribution fees fell 0.2% to £488m and operating profit rose 7.3% to £86m.

Adjusted net debt rose £518m compared to last year to £13.5bn, reflecting the lower profitability, adverse currency movements, share buy backs, acquisitions and a Russian tax settlement.

The group expects COVID-19 to reduce full year earnings per share by low single digits, reflecting the loss of most duty free sales, manufacturing restrictions and customers choosing cheaper brands. Imperial expects the sale of the Premium Cigars business to complete in July for £1.2bn, which will be used to pay down debt.

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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.