Imperial Brands rewarded for impressive returns

Changing lifestyle habits and tougher regulation perennially overhang this sector, but in the meantime Imperial Brands (LSE:IMB) continues to play the cards it has been dealt with aplomb.

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Quite apart from the changing landscape and the burden of regulatory censure which has plagued the sector over recent years, there is also a reluctance among some investors to invest in tobacco companies at all on ethical grounds.

As such, the tobacco companies are racing towards Next Generation Products (NGP) as an alternative, and are doing so from a relatively recent standing start. Even after some years of investment, the NGP unit is still loss-making for Imperial, although there are clear signs of progress. Net revenue growth for the 12 months to 30 September was 26%, and the NGP unit now accounts for 8% of total revenues. The adjusted losses of £79 million represented an improvement of 43% as this part of the business edges towards profitability. 

Elsewhere, 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. Indeed, while tobacco volumes fell by 4% over the year, net revenue for the group increased by 4.6% to £8.16 billion, showing the benefits of strong pricing.

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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 and a stabilising Germany are offsetting declines in the UK. 

As such, the group retains its ability to choose between shareholder returns, investment in the business, paying down debt or indeed all of these. At the present time, shareholder returns are in sharp focus, with the announcement of a further share buyback of £1.25 billion, as part of a multi-year programme. At the same time, a further increase to the dividend lifts the current projected yield to 6.4%, which adds to what has been a significant total return for shareholders.

Net debt continues to decline, moving from £8.03 billion to £7.74 billion over the year and an adjusted operating profit of £3.91 billion is an improvement of 4.6% from the corresponding period, albeit marginally shy of estimates.

By region, Europe accounts for 41% of group revenue, the Americas 35% and Africa, Australasia, Central and Eastern Europe the balancing 24%. Within these regions, the group has been tailoring specific brands to specific regions, even within countries, which has had some positive results. The group continues to focus investment in its top five combustible markets, while there have also been a number of NGP launches which have further boosted the longer-term aim of less reliance on traditional combustible products. 

In terms of outlook, the group is focused on completing its current five-year strategic focus, with details of the next leg of the strategy to be announced next year. In the meantime, the group expects revenue growth to continue in the low single digits and for adjusted operating profit to increase by a mid-single digit number. The aggressive shareholder return programme should, all things being equal, continue to underpin the share price.

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Indeed, the total return has of late been impressive for Imperial. Apart from the additional dividend bonus, the share price has risen by 30% over the last year, as compared to a gain of 8.2% for the wider FTSE100, and the shares have now added 52% over the last three years while the transformation programme has been in full swing. 

Even after such a climb, the shares are not obviously expensive in terms of historic valuation. Despite the 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, and the market consensus of the shares as a buy continues to reflect this bounty.