Plenty More Puff in Imperial Brands

At 3,783p a share, Imperial Brands offers an estimated strongly increasing dividend payout, giving an equally attractive estimated dividend yield for this year and next.   

The business

Imperial Tobacco is no more: it is now known by the less pejorative and much blander name of Imperial Brands (IMB); its share price mnemonic has changed from IMT to IMB.

I assume that this is attributable to the arrival of electronic non-tobacco cigarettes rather than arising from any sense of opprobrium attached to tobacco manufacturing. After all, tobacco had been part of the name for many years. It now distributes the non-tobacco products – basically e-cigarettes – of other manufacturers, thus concentrating more of its net cash flow to dividend paying. As stated below, it is now licensing out its technology, which should start to make a contribution to last year’s undernourished net margin of less than 4 per cent.

Consequently, the company now prefers to describe itself as a fast-moving consumer goods company; a manufacturer and purveyor of the products of a tobacco portfolio from which are supplied cigarettes, fine cut and smokeless tobaccos, papers and cigars.

The Company’s regional markets are unusually described as ‘Returns’ markets: North; South; Growth Markets (which includes its Cuban joint ventures and Fontem Ventures); USA and Logistics. ‘Returns’ Markets North includes Australia, Belgium, Germany, Netherlands, Poland and the United Kingdom.

Its Returns Markets South includes France, Spain and its African markets, including Algeria, Ivory Coast and Morocco. Its Growth Markets segment includes Iraq, Norway, Russia, Saudi Arabia and Taiwan. Its business includes Tobacco and Logistics. The Logistics business comprises the distribution of tobacco products for tobacco product manufacturers.

Recent share price history

I last looked at Imperial Tobacco in December last year and note that I judged it a hold and preferable to BAT, partly because I perceived the company at less risk to plain packaging. British American Tobacco is on my observation a more brand-led, higher net margin business than Imperial Brands. Last year, although Imperial Brands sales were twice the size of those of British American, its net margin was dramatically lower than that of its rival: a mere 3.8% in contrast with 33% at British American Tobacco. In theory, if not in fact, a company which looks more likely to be the object of a major takeover in any final act of an ultimate end game in the consolidation of the industry, rather than the perpetrator of any such move, will thus give short-term priority to keeping shareholders happy with increasing dividends. At least that is my own perspective on the subject.

A long time expiring

All of the above is based on a fundamental long-term idea that the days of tobacco enterprise are numbered – except, as I always observe, they seem to have been in that condition for most of my professional life, but still persist in growing dividends at above average rates for longer than the pessimists ever thought possible. Dividend growth over the last five years has been at the champion rate of 10.8 per cent. Those dividend increases have driven tobacco company share prices forward year on year and still appear to persuade investors that the scope for attractive increases still exists for another two or three years ahead. As you will note below, that is still the case.

Thus, in the case of Imperial Brands over the last five years, the share price has grown in total in excess of 75 per cent. In contrast, the value of the market as measured in the shape of the FTSE 100 Index has scarcely risen, with an increase of a mere 3 per cent or so over the last five years. I daresay that five years ago, given the pressure brought to bear by governments on smokers, that would have appeared unlikely. If anything better supports the idea that long-term investment portfolios should be sufficiently diversified to reduce risk and increase security of returns, it is this performance from the ‘doomed’ tobacco shares, which have confounded rational pessimism for years. But caution remains and we are always, at each annual set of results, left nervously looking for signs that the long upward trend in tobacco share prices and dividends may be changing.

The latest and growing threat is of course plain packaging of branded products as a logical dent to market share. Interestingly, Imperial appears not to have seen that to any significant extent (so far) in Australia, which has been the test bed of government inspired attempts to reduce the harmful consumption of tobacco products. It seem likely that this may prove to be a long-term threat to brand loyalty because it is a denial of packaging as a marketing and advertising  tool in winning new customers.

To judge from the comments of the company, it sees progress in ‘quality’ growth from its leading brands Winston and Gauloises and ‘specialist’ brands like the ugly sounding ‘Skruf’. These were reported as providing more than 58 per cent of total tobacco net revenue.

With regard to the compensatory e-cigarettes market, the company seems understandably upbeat about managing the conversion of its existing tobacco smoking customers to its alternative non-tobacco products. Imperial is reported to have 14 per cent of the global tobacco market, so it has a big sales base to convert. Rather surprisingly perhaps, the company also reports that it is now licensing its technology to other e-cigarette companies which, if successful, should see licence fee income fall straight to Imperial’s bottom line of profitability, helping to improve the below average net margin.

Earnings and dividend estimates

So what does the market expect from the company this year and next in terms of earnings per share and annual dividend payouts? The latest consensus market estimates and forecasts show a bullish view of earnings this year and a positive view of estimated earnings next year. That is to say, it is the consensus view that earnings will increase 12 per cent this year to December 31^st 2016 and 6 per cent the following year. Dividends are forecast to rise an estimated ten per cent this year and almost ten per cent next year. In explicit terms, a forecast of earnings per share of 230p this year and 254p next year, which at the current (last seen) share price of 3,783p, values the shares at prospective earnings multiples of 15.6 and then 14.6 times and on forward dividend yields of 4.1 per cent and 4.5% for next year. I add for the record that the consensus estimated dividend payments are of 155.4p for the current year and 170.8p for next year.

At this stage the share price chart is evidencing some well established resistance at 3,800p and 3,926p. The latest share price at 3,783 is close to that now. I suggest that current forecasts are strong enough to push the share price through that barrier, confirming the long established uptrend in the share price, which looks to me as though it could reasonably get towards 4,000p at some point. As an indicator as to where the share price might go, on the assumption that the company does achieve the consensus estimated 254p per share of earnings that year, we might apply the current historic price to earnings ratio of 17.85 to that number to obtain the equivalent share price of 4,534p. Naturally, one is also making a further assumption that the outlook for the years 2018 and 2019, when they come, will be equally encouraging in terms of dividend and earnings estimates.

In terms of the affordability of dividend payments by Imperial Brands, operating cash has grown strongly over the last three years from a reported £2.35 billion 2013 to £2.74 billion in 2015. That was enough to cover the cost of the annual dividend last year more than twice. As operating cash flow has risen, capital spending on the business has decreased in each of the last three years, with the company raising debt to cover most of the cost of corporate investments in 2015. In short, at the end of 2015 the management had cash of £2.0 billion after the payment of the 2015 annual dividend. Moreover, that year-end cash figure was up nearly 50 per cent on the year-end cash figure in the previous year.  It is also encouraging that the company can still borrow for cash generative deals, as it did last year, despite the massive debt to equity gearing ratio of 2.93.

Given the background it is worth noting that although the shares do have net assets worth an estimated 510p a share, it has no net tangible assets. It is also to be noted that shareholders’ equity, accounted for at £5.3 billion, commands total assets that are 5.75 times the equity value. Total assets last year, increased 16 per cent whilst equity increased 5 per cent.