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Imperial Brands - tobacco prices up, volumes down

Half year revenue, excluding duties and the impact of exchange rates, rose 0.3% to £3.5bn...

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Half year revenue, excluding duties and the impact of exchange rates, rose 0.3% to £3.5bn. Tobacco revenue rose 0.1% as higher prices were able to offset a 0.7% decline in volumes. Next Generation Products (NGP) reported 8.7% net revenue growth, driven by a strong performance in Europe.

Underlying operating profit rose 2.9% to £1.6bn as NGP losses reduced by 49.9%.

The group remains on track to deliver full-year net revenue growth of around 0-1% and underlying operating profit growth of 1%.

The board announced an interim dividend of 42.54p, 1% higher than last year.

The shares rose 4.2% following the announcement.

View the latest Imperial Brands share price and how to deal

Our view

At the halfway mark in the second year of Imperial Brands' 5-year strategy, focus remains on improving market share in core markets - the US, UK, Spain, Germany and Australia - which account for around 70% of profits. To its credit, the new strategy does appear to be yielding some results, over the first half the group gained an average market share over the core markets of 0.25%, up from a 0.16% average drop over the last 5 years.

Helped by the sale of the Premium Cigar business last year, net debt has dropped in line with the group's target of 2-2.5 times earnings. And that's given management the confidence to start the slow process of re-growing the dividend.

That makes profit growth the main area of focus. Price increases have been able to prop up sales despite declining volumes, but that's a short-term solution. Next Generation Products (NGPs), like heated tobacco and vaping products, offer a route for growth, but it's not been an easy start. Management responded to its NGPs' lukewarm reception by exiting unprofitable markets, homing in on those it felt had more potential. It's early doors, but trials look promising and broader rollout for vape and heated tobacco products is underway.

Investment in these new products will weigh on performance in the short term, and the NGP division is loss making, albeit losses are reigning in. It's the right move if a narrowed focus helps the group build out successful cigarette-alternatives, but there's a long way to go before these products start to make a meaningful positive impact on performance.

As the smallest of the four tobacco giants, rumours often swirl that Imperial will get bought out by one of the bigger players. This 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. An investment case should therefore be generally built around the dividend yield, which is currently substantial, and the NGP prospects.

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. It was a bold move to start over with new products, but one that was ultimately necessary. In truth, we're a long way off being confident the new round of products will be able to scale up, but progress is moving in the right direction. A prospective dividend yield of 8.5% makes the uncertainty more palatable, but as always there are no guarantees.

Imperial Brands key facts

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.

Half Year Results (ignoring effect of exchange rates)

In Europe, revenue fell 2.2% to £1.6bn. That was driven by the unwinding of some favourable conditions seen during lockdowns and the return of travel. The group gained market share in the UK but lost in Germany and Spain. Price increases in the UK and Germany should feed into a better price performance in the second half of the year. NGP revenue rose 44.7%, although that wasn't enough to offset falling tobacco revenue and underlying operating profit fell 7.3% to £671m.

The Americas saw revenue rise 2.2% to £1.2bn, driven by strong cigarette performance in the US despite an overall industry volume decline. NGP revenue dropped 28.1% as competition heats up and discounted prices take their toll. Underling operating profit rose 6.0% to £453m, benefiting from market share gains and lower NGP costs.

Africa, Asia and Australasia saw revenue 3.1% higher to £766m. The group gained market share in the region's key Australian market, aided by the launch of Lambert & Butler as a better value offering. NGP revenue fell to zero, following the exit from underperforming markets in Japan and Russia. Underling operating profit rose 25.8% to £357m.

Distribution posted revenue of £502m, down 0.6%. That comes as strong performance in Iberia was more than offset by weakness in France and Italy. Underlying operating profits grew 1.0% to £119m.

The group realised a charge of £201m over the period relating to the disposal of its Russian business.

Free cash flow for the period came in at £336m, helping net debt reduce by £1.2bn to £9.8bn. The ratio of underling net debt, which excludes lease liabilities, to cash profits (EBITDA) dropped to 2.4 times. The group's on track to reduce that to the lower end of 2.0-2.5 times.

This article is original Hargreaves Lansdown content, published by Hargreaves Lansdown. It was correct as at the date of publication, and our views may have changed since then. Unless otherwise stated estimates, including prospective yields, are a consensus of analyst forecasts provided by Refinitiv. 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.

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Written by
Matt Britzman
Equity Analyst

Matt is an Equity Analyst on the share research team, providing up-to-date research and analysis on individual companies and wider sectors.

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Article history
Published: 17th May 2022