Imperial Brands Group (IMB) Ordinary 10p
HL comment (26 September 2019)
Imperial now expects full year revenues to rise 2%, with earnings per share flat year-on-year. That's lower than previous guidance and reflects the challenges in the US Next Generation Product (NGP) market and poor results in Africa, Asia and Australasia (AAA).
The shares fell 8.9% in early trading.
Imperial's main attraction has long been the sizeable and growing dividend. However, impressive growth of 10% a year wasn't enough to stop the shares falling more than 50% between late 2016 and mid-2019.
With the dividend yield approaching 10.6%, management have 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 investors can reasonably expect in the current climate, and throwing money at shareholders won't make the shares more attractive.
As the price to earnings ratio has fallen, currently at 7.2 times, buying back shares has become more attractive. 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 customers are giving up 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 that could 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 reducing costs 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.
However, investment will slow rather than reverse declines, making Imperial's vaping and heated tobacco products crucial to longer term success. A recent marketing splurge had started heating things up, but a string of vaping related deaths in the US has thrown the future of the sector into question. Time will tell how badly it undermines the sector's key growth driver.
Pre-Close Trading Update
NGP sales are expected to grow by around 50% this year - below previous expectations. That follows increased regulatory scrutiny in the US, with some retailers not ordering or not allowing the promotion of vaping products. The market has also seen increased competitor discounting, hitting revenues and profits. Progress in Europe and Japan has been more positive.
The tobacco business is on course to deliver low single digit revenue growth, with higher operating profits. Good results in Europe and the Americas are expected to more than offset weaker trading in AAA.
The group expects to realise £300m in cost savings by September 2020, with underlying cash conversion in line with previous guidance.
The group completed a $123m Canadian dollar investment in Auxly Cannabis on 25 September - working with the group on the development of cannabis products. The planned sale of the premium cigar business is said to be progressing well, with Imperial on track to achieve disposals worth $2bn by May 2020.
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.
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Previous Imperial Brands Group updates
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