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Is Imperial Tobacco Group PLC Dead In The Long Term?

A business steeped in history, death and misery

After a long and complicated corporate history that dates back to the beginning of the 20th century, Imperial Tobacco (LSE: IMT)(NASDAQOTH: ITYBY.US) was spun out of the conglomorate Hanson Trust in 1996. Today the company employs 37,000 people and owns some of the world’s most successful tobacco brands.

The problem is that smoking kills. Many consumers can hardly afford the product and only buy because they are addicted. Ethical and public health concerns are forcing governments worldwide to increasingly tighten the rules around marketing, sale and consumption of tobacco products. Add in the threat posed by e-cigarettes and you have a toxic profit-destroying cocktail.

Pain, no gain but dividends to die for

Now it is shareholders’ turn to feel the pain. In the last two years, shares in Imperial Tobacco have broadly gone nowhere. So far this year, the stock is unchanged while the FTSE 100 is 13% higher.

However, Imperial has not disappointed income investors. The company has been paying a growing dividend since 2003. With its interims earlier this month, the company confirmed its intention to increase dividends annually by “by at least 10 per cent per year over the medium term.”

Forecasts

Unfortunately, the outlook for earnings growth is less impressive. Forecasts for 2014 profits have been falling month-on-month for the last year. Twelve months ago, analysts were forecasting earnings per share of 232p from the company. Today, that is 217p. While that s a cut of just 6.5%, the reduction in expected growth is significant.

With anti-smoking regulations tightening worldwide, for how much longer can Imperial continue to deliver profit growth?

Verdict

The sector has wobbled recently following some bearish comment from US giant Philip Morris. The Marlboro-maker has forecast big sales declines in Europe, including an eye-catching forecast of a fall of as much as 11% in Russia next year.

Government controls, tax rises (encouraging counterfeiting) and consumers having better access to education will prolong this trend.

Add in the rise of less profitable alternatives (e-cigarettes) and the long-term outlook for industry is bleak. I expect Imperial to be priced as an ex-growth stock within two years. Moreover, I am confident that once growth leaves this business, it will never come back.

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> David does not own shares in any of the companies mentioned.