Imperial Brands - I don't use the products but hello cash machine

By Chris Bailey | Wednesday 8 November 2017

Disclosure: I own shares in one or more of the stocks mentioned. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from ShareProphets). I have no business relationship with any company whose stock is mentioned in this article.

The last time I wrote about Imperial Brands (IMB) HERE, there were a few overly excitable comments made. As noted last time, I have never smoked but have no moral hang-up to investing in the sector. If you do...then I guess you have stopped reading or I look forward to your comments. Anyhow, since my original piece the stock is slightly down but only by a percent or two and full year preliminary numbers highlight an improving second half of the year showing a touch of revenue and EPS growth.

This as prices were raised and market share gains were made in some of its key cigarettes markets including the US, the UK, Germany, Russia, Japan, Saudi Arabia and Italy via some of its key brands including West, Winston, JPS Players and Gauloises. All very par for the course for a consumer staple with a brand portfolio. The difference though with a tobacco company compared with a Nestle or Unilever (ULVR) is that the core tobacco product is changing.

Imperial Brands has been a bit behind-the-curve on next-gen tobacco (and non-tobacco related) products such as e-vapour, heated tobacco and smokeless. As the Imperial Brands internal guru noted on the conference call the keys to making a success of this area are first to focus on the transition of smokers from cigarettes to other products whilst, second, keeping the correct side of the regulatory and public health debate. Absolutely.

The £300 million investment that the company is making in its e-vapour brands like blu and Nerudia is all about it trying to play a bit of catch-up but also protect its core competency which is cigarette smokers who progressively are being pushed into alternatives to a classic fag. This is much more about defence for the company and why if you fancy a proper pukka next-gen tobacco products play you are far better off looking at someone like Philip Morris International or even British American Tobacco (BATS). Still Imperial is doing something and it sounds vaguely sensible. One reason for investors to be a bit happier with the stock.

The real reason to be happier though is the cash flow. Dividend munchers will be all over the 5% yield and the 10% dividend rise promise is being adhered to. For me, I look behind the dividend and muse about affordability because the company - after a cracking US acquisition a couple of years ago - does have a net debt level that is three times its current ebitda (a multiple which should have you looking intently at the balance sheet). However after leafing through I really did like the near 8% free cash flow yield - aided by an ongoing cost compression exercise - which allows it to push down debt and pay that dividend.

My only real issue was that the headline results were boosted on translation by the wayward Pound. Ultimately Imperial Brands is not a big growth business but it is still a cash machine and the value of that dividend flow and a bit more free cash on top is too cheaply valued in my view. The cherry on the top of the cake would be any M&A that involved the company (hello Japan Tobacco) but you cannot plan for that.

Bottom line though I liked the results...and you can make your own choices about the products. As for the shares though I remain a buyer. This should be in the upper half of the £30-40 range with the dividend wrapped around too.

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