Underlying revenue is expected to grow at 1% driven by strong tobacco pricing. Together with reduced losses in Next Generation Products (NGP) and improved performance in Distribution, this should feed into underlying operating profit growth in the low to mid-single digits, as expected.
CEO Stefan Bomhard said, "We have made good progress in implementing our strategy through a sharper management focus, greater investment behind our priority combustible tobacco markets and new market trials in heated tobacco and vapour."
The shares fell 1.4% following the announcement.
Historically smokers' willingness to pay ever higher prices meant tobacco giants were able to protect profits and grow dividends even as the smoking population dwindled. However, Imperial recently took the bold, but necessary in our view, decision to cut its dividend by a third to focus on debt reduction and investing behind a sharper proposition.
Helped by the sale of the Premium Cigar business, Imperial has improved its debt position over the past six months and is now carrying about 2.6 times net debt to underlying cash profits, which management wants to bring down to 2-2.5 times by the end of 2022. That's also given management the confidence to start the slow process of re-growing the dividend.
With debt coming under control, profit growth is the main area of focus. It will be essential if dividend growth is to be sustained from the lower base. 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. The group's expecting profits in its cigarette business to decline this year, though that's in large part due to disruption in Australia and US legal fees. The return to normal shopping patterns post-Covid isn't helping matters either as customers are funnelled away from more profitable purchases. We think this year's decline will be a one-time dip, but we can't rule out the possibility that it will become an ongoing problem.
Next Generation Products (NGPs) offer a potential future opportunity, and Imperial has primarily invested in vapour via its blu brand. Health scares and legislation in the US have severely knocked progress and sent growth into reverse. Management's responded to NGPs' lukewarm reception by exiting unprofitable markets, homing in on those with potential and exploring heated tobacco products. This will weigh on sales in the short term, but it's the right move if a narrowed focus helps the group build out successful cigarette-alternatives.
As the smallest of the four tobacco giants, rumours often swirl that Imperial will get bought out by one of the bigger players. This certainly isn't imminent though - and we think competition regulators would prove a major hurdle given the already high degree of market concentration.
The other important thing to consider with tobacco stocks is that many institutional investors can't, or won't, invest in the sector. 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. Any investment case therefore has to be built around the dividend yield, which is substantial, even after the cut.
In the medium-term, Imperial can probably continue to squeeze more money out of fewer smokers. But further into the future, it's NGPs that will be driving this train. As it stands, that doesn't fill us with a lot of confidence. A prospective dividend yield upwards of 9% makes the uncertainty more palatable, but as we saw last year, there's no guarantee it will remain so lofty.
Imperial Brands key facts
- 12 month forward Price/Earnings ratio: 6.3
- 10 year average 12 month forward Price/Earnings ratio: 10.6
- Prospective yield: 9.3%
All ratios are sourced from Refinitiv. Please remember yields are variable and not a reliable indicator of future income. Keep in mind key figures shouldn't be looked at on their own - it's important to understand the big picture.
Within Combustibles, increased investment across the group's priority markets is expected trim market share losses to a 0.02% to 0.03% decline, compared to a 0.17% decline last year. This coupled with lower revenue in Australia and US legal costs is expected to drive underlying operating profits lower, as previously guided. Overall tobacco volumes should be in line with expectations, with cigarette market share expanding by around 0.20%. Relaxed Covid travel restrictions could result in a small, unfavourable change in product mix.
Second half revenue in Next Generation Products is expected to be in line with the first half, as the group continued to exit markets with lower growth prospects. The group's launched heated tobacco trials in the Czech Republic and Greece and is testing new marketing strategies for blu in the US.
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