While the FTSE 100 index has generally been heading upwards so far in 2019, Imperial Brands (LSE: IMB) has been going the opposite way, with the share price down by 21%. For comparison, competitor British American Tobacco shares have risen so far this year, up by nearly 13%. The question is, does this now make Imperial’s share price seem too cheap?
The big issue
The big challenges for Imperial Brands all relate to the problems of growing in developed countries when there’s so much social, political and regulatory pressure on smoking. Just last month, the cigarette producer had to refute estimates by Nielsen of a big drop in tobacco sales across the industry. Nielsen tracking data indicated that cigarette industry volumes fell 11.2% in the four-week period ending May 18 to mark a deceleration from the -9.5% 12-week pace, according to Wells Fargo. Over the past 52 weeks, Imperial said that its own sales had fallen by 4.9%.
Clearly then, and this won’t come as a shock, volumes are declining. But the crucial question is: what does that mean for the future?
Addressing the elephant in the room
If Imperial Brands cannot grow volumes in its developed markets, it relies on raising prices, expanding in emerging markets, new products and aggressive cost-cutting.
On the cost-cutting front, Imperial is on course to deliver £300m of savings by September 2020, but this year’s savings will be lower than previously thought, at £60m. New products are doing well, as shown in the half-year results, although US regulators are taking a closer look at their impact, which has weighed on the share price and will likely continue to do so.
In countries the producer calls ‘growth markets’ (typically what would be deemed emerging markets), where regulation is lagging behind, Imperial gained market share, rising from 4.3% to 4.7%. But at the same time, operating profit fell just over 11%, indicating it is having to invest a lot to grow.
The shares
The shares themselves look like a steal – the P/E is under seven and the dividend yield is just a little over 10%, one of the highest in the FTSE 100. And the company remains committed to annual dividend increases of at least 10% in the “medium term“. With the share price having fallen, the shares look cheap in comparison to British American Tobacco, which has a yield of 7.2% and a P/E of nine.
It comes down to whether you believe the opportunities for growth outweigh the decline in Imperial’s core product, cigarettes. At the moment I remain unconvinced of its potential. And Imperial is smaller than British American Tobacco, which could make it weaker as scale becomes ever more important in this changing industry. So I’ll stay on the sidelines, even though for braver investors, the combination of a share price that looks cheap and a very high yield with a low P/E might be appealing.
