Imperial Brands excels on miserable day for markets

Investors have much to ponder after unsettled US and choppy Chinese markets washed over to UK shores, with Middle East conflict concerns adding to a cautious mix.

In the US, the consensus has now convincingly swung to the likelihood of a 0.25% interest rate cut in November after last week’s stronger-than-expected non-farm payrolls report. Further dampening enthusiasm was a court order on Alphabet Inc Class A (NASDAQ:GOOGL) for Google to overhaul its mobile app business, while broker downgrades weighed on Amazon.com Inc (NASDAQ:AMZN) and Apple Inc (NASDAQ:AAPL).

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Amid the uncertainty, the quarterly reporting season begins in earnest later this week, with updates due from the likes of JPMorgan Chase & Co (NYSE:JPM) and Wells Fargo & Co (NYSE:WFC). In the meantime, the main indices remain in good shape despite the current turmoil, with the Dow Jones having added 11.3% so far this year, alongside a gain of 19.4% for both the S&P500 and Nasdaq.

Asian markets surged at the open after a week-long holiday break in China, but gains were somewhat eroded as investors reacted to a perceived lack of detail from the authorities following the recently announced raft of stimulus measures. In contrast, the Hang Seng index opened down by more than 10% before halving its losses as the day wore on, while the Nikkei index slipped as the yen strengthened against the dollar, weakening the shares of exporters in particular.

The reticence for buyers to commit was also in evidence in the opening UK exchanges, with the main indices under pressure.

While the premier index has seen some support over recent days given its large exposure to defence and oil companies, profit takers locked in gains after the recent rally in the commodity, sending the benchmark Brent Crude price down by more than 1.5%.

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Additional pressure came from the Asian overhang, where mining stocks and the likes of Prudential (LSE:PRU), HSBC Holdings (LSE:HSBA) and Standard Chartered (LSE:STAN) felt some discomfort given their exposure to China. Completing a triple whammy was weakness in the housebuilding sector given some cautionary comment and a profit warning from Vistry Group (LSE:VTY) which sent the shares down by more than 30% and which weighed heavily on other players within the sector.

The broad weakness reduced gains in the year so far to 6.3% for the FTSE100, with the current assault on sentiment from many angles likely to persist for the time being.

Imperial Brands

The pressure on traditional tobacco products has been in evidence for some considerable time, driven mainly by changing lifestyle habits. This adds to the burden of regulatory censure which has plagued the sector over recent years and a reluctance among some investors to invest in tobacco companies at all on ethical grounds.

At the same time, the need for a long-term replacement for traditional combustible products left the tobacco majors needing to move from a standing start, and even after some years of development the Next Generation Product (NGP) unit is still loss-making for Imperial Brands (LSE:IMB), although there are clear signs of progress in this update ahead of annual results next month.

Indeed, net revenue growth for NGP is expected to be in the region of 20% to 30%, although whether such growth can be maintained at a pace which can even begin to offset the decline in combustibles remains a core question overhanging the sector, let alone whether the current levels of margin and profitably can be replaced.

In the meantime, the tobacco majors continue to benefit from the extraordinary cash generation which their sector enables. Tobacco remains a product which has inelastic demand, providing the ability to raise prices without unduly dampening demand and this pricing mix has seen the benefit as a result, with falling volumes more than offset by higher prices.

In addition, the group continues to focus investment in its top five combustible markets, which account for around 70% of overall operating profit, and where growth in the US, Spain and Australia is broadly offsetting declines in the UK and Germany. 

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As such, the group retains its ability to choose between shareholder returns, investment in the business, paying down debt or any combination of these. In this update, shareholder returns are in sharp focus, with the announcement of a further share buyback programme of £1.25 billion, while increases to the dividend lift the current projected yield to 7.1% and to a highly attractive 8.8% next year.

This is a welcome bonus to an overall total return which has seen the share price rise by 29% over the last year, as compared to a gain of 10.8% for the wider FTSE100 and where a warm reaction to the update is in sharp contrast to broad weakness elsewhere within the premier index at the open.

Indeed, despite the longer-term concerns of changing habits and a more immediate drag from some large investors either unwilling or unable to buy tobacco shares, Imperial is maximising its current power with the market consensus of the shares as a buy reflecting this bounty.