Questor share tip: Imperial Tobacco a solid defensive option

Imperial Tobacco
£27.77+110p
Questor says HOLD

IMPERIAL Tobacco [LON:IMT] has once again proven its credentials as a defensive share, with a healthy dividend.

The company showed yesterday it can manage falling cigarette volumes and revenues by increasing prices and cutting costs, leading to a healthy jump in profits.

Management said reported pre-tax profits jumped 25pc to £1.52bn in the year ended September. The results were in line with market expectations.

Investors were rewarded with a 10pc increase in the annual dividend to 128.1p, ex-dividend on January 15 and payable on February 17.

Questor said the shares were an “an excellent place to park cash” when they were changing hands at £25.85 on August 20 - and so they have proved. The detail of the full-year results demonstrate why.

The FTSE 100-listed tobacco giant, which makes Davidoff and Gauloises Blondes, sold 294bn cigarettes in the year ended September 30, a 7pc fall. Revenues dropped 6pc, to £26.62bn, in the period.

The company is combating falling sales by steadily increasing prices and keeping a tight control on costs. Price increases of more than 6pc were put through during the year and the company removed £60m from the cost base. Management added that they remain on target to cut £300m a year by 2018.

The adjusted pre-tax profits were down 2pc to £2.5bn, when £1bn in

one-off events such as acquisitions, disposals and financing are taken into account. These are more muted than the reported figures but they are stable, which allows tight management and efficiency.

Even though cigarette sales are struggling in the developed world, the company is pushing its brands in emerging markets to drive sales.

Growth brands such as Davidoff, Gauloises and Lambert & Butler reported rising market share and steady revenue, and now contribute 41.6pc of group sales, up from 38.9pc at the end of last year.

The cigarette maker is also generating plenty of cash, with operating cash flow increasing to £2.55bn in the year, up from £2.35bn last year. The level of net debt was cut to £8.1bn at the end of September, down from £9.1bn a year earlier. The cost of interest payments fell to 4.9pc from 5.1pc last year, which may sound small but on £8.1bn of debt each basis point of interest is worth around £81m.

Imperial aims to return spare cash to shareholders. In addition to the dividend increasing at an inflation-beating 10pc in the year, the company spent £341m buying 14.2m shares.

The group is expanding by spending £4.2bn on buying US cigarette brands Winston and Kool, as part of the $25bn (£15bn) merger between two of the world’s biggest tobacco groups – Reynolds American and Lorillard. The deal will see US revenues increase to about a fifth of the group total.

Alison Cooper, Imperial’s chief executive, reassured investors that a rights issue would not be needed to complete the deal, as debt financing was already in place.

Net debt is expected to increase by £4bn to £12bn when the deal closes in the first quarter of 2015.

The share buyback programme was suspended in July and Ms Cooper said it would be reviced once cashflow and earnings from the US business are clearer.

Imperial has been slowly moving into the growing e-cigarettes sector, and launched its own version this year through its Fontem Ventures unit. It has been behind its main UK rival, British American Tobacco (BAT), which launched its first e-cigarette last year.

Imperial Tobacco shares have risen more than 18pc so far this year, easily outperforming the FTSE 100, which has fallen 4pc. Now trading on a forecast price-to-earnings ratio of 12.6 times, they are cheaper than BAT on 17 times earnings, and only marginally above their long-run average PE of about 12 times.

Imperial’s balance sheet is strong and the company looks attractively priced. Hold.