Disappointing Imperial Brands update dumps shares to multi-month low

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 carefully. However, in simply maintaining its guidance rather than pointing to an immediate catalyst, the share price has been met with some disappointment in opening trades. 

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Quite apart from the shifting 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. 

However, even after some years of investment which is currently incorporating higher marketing spend, the NGP unit is still loss-making for Imperial, although there are clear signs of progress. The group previously announced that net revenue for the full year grew by 13.7% to £368 million, leading to cumulative growth of 83% over five years and now accounting for 11% of total revenues. Double-digit revenue growth is also anticipated for this year as a whole, which may help this part of the business continue to edge towards profitability.

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For the group as a whole, low single-digit revenue growth is expected for the first half, with adjusted operating profit expected to be higher than the corresponding period last year. For the full year, adjusted operating profit should accelerate in the second half, leading to an overall improvement of between 3% and 5%. In terms of its markets, Europe and AAACE (Africa, Asia, Australasia, Central and Eastern Europe), which together account for 65% of group revenues are driving growth, offset by some weakness in the US and Australian markets.

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 robust pricing, which has led to forecasts of £2.2 billion of free cash flow for the full year. 

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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 current £1.45 billion share buyback programme half-complete, as part of its multi-year programme. At the same time, a dividend yield of 5.2% adds to what has been a significant total return for shareholders. The aggressive shareholder return programme should, all things being equal, continue to underpin the share price.

Progress has been more pedestrian of late, with the shares having risen by 6% over the last year prior to today’s dip, as compared to a gain of 30% for the wider FTSE100. Over the last two years, however, the price has spiked by 80% even though the transformation programme has been in full swing. Even after such a climb, the shares are not obviously expensive in terms of historic valuation and despite the obvious 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 earnings power. 

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As such, the market consensus of the shares as a strong buy and the preferred play in the sector continues to reflect this ongoing bounty.

Results for the six months ended 31 March will be announced on 12 May.