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Imperial Brands - fade the moral outrage & buy

By Chris Bailey | Tuesday 6 November 2018

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.

Time for another write-up on Imperial Brands (IMB)...and no doubt time for a bunch of criticism in the comments about how this is an uninvestable sector. Well I do not smoke, would not want my children to smoke/use tobacco-based products but - in a modern world of information and regulation/taxation - I respect the right of adults to do so and I remain perfectly comfortable in investing in the sector. Otherwise, where do you draw the investing line? Alcohol? Defence? Gambling? Clothing names who directly or indirectly use child labour and lots of water? Energy and mining names due to their use of the world's assets? You get the gist.

Since my last write-up HERE, operating progress has been fine and today's full year numbers showed (in constant currency terms) net revenue up 2%, earnings per share up 5% and dividends per share up 10%. Not exciting per se...but this is a value/income play and the uplift of the dividend to a cool 6.9% at prevailing is somewhat better than a FTSE-100 average. Scrape below the headline numbers and the numbers are clearly a tick in the box. The best growth is coming from its strongest brands (Davidoff, Winston, West, JPS etc.), there has been continuing good pricing power, ongoing cash conversion of near 100% and a healthy nudge down of the debt level (to x2.9 ebitda now) despite the aforementioned dividend largesse.

So why is Imperial Brands so down in the dumps trading at that big old dividend yield? Well we all know the tobacco market is changing and evolving, with 'next gen' vaping, burnable technology and related products progressively crowding out classic cigarettes. Imperial has a strapline of 'creating something better for the world's smokers', but the market perception has been that it is behind some global peers and risks losing out to them or newbies on the block - one of this latter grouping Juul has made a big splash in the US and has just launched in the UK. My observation is that Imperial Brands - helped out by a long industry experience, regulatory know-how and great distribution systems - is having some success with building its premier vaping brand blu.

Now none of this is costless and further investments in the next gen space will hold back profitability a tad but the overall business is set to push up profits again next year and - very importantly - it reiterated the 10% pa dividend hike. Even more importantly it noted that by the end of next year, the sale of a blu pod will actually be gross margin enhancing within the UK market. As it put it in the presentation: 'positive unit economics with pod net revenue greater than cigarettes'. Wow.

From a valuation perspective the company still trades at a single digit EV/ebit level with that big dividend yield. Even putting it on a pretty undemanding x10 forward EV/ebit ratio gives you a thirty quid plus share price - and that dividend yield. For me this is one for much more than just the dividend munchers. Buy.

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