The Pros And Cons Of Investing In Imperial Tobacco Group plc

Stock market selections are never black-and-white decisions, and investors often have to plough through a mountain of conflicting arguments before coming to a sound conclusion.

Today I am looking at Imperial Tobacco Group (LSE: IMT) (NASDAQOTH: ITYBY.US) and assessing whether the positives surrounding the firm’s investment case outweigh the negatives.

Market difficulties weigh heavy

Make no mistake: tough market conditions in the tobacco sector are threatening to derail Imperial Tobacco’s relentless growth story of recent years. Indeed, a combination of economic pressure on customers’ pursestrings, and the impact of escalating health worries, are weighing heavy on the growth outlook for the entire sector.

The company noted in its full-year results this month that, on a constant currencies basis, tobacco net revenues slipped 1% in the 12 months to September 2013 to £7.01bn. And tobacco adjusted operating profit edged just 1% higher to £3bn.

Brands keep punching

But, encouragingly, Imperial Tobacco can lay claim to holding some of the best and most prestigious cigarette labels in the business, whose formidable pricing power continues to drive turnover.

Despite a 2% fall in volumes of its “Growth Brands” during the year, to 129bn sticks, net revenues from these labels — which include the likes of John Player Special, West and Gauloises Blondes — actually rose 2%. The company increased market share in these brands by 30 basis points last year, and the firm has vowed to ratchet up investment in these labels.

Losing the e-cigarette race?

The company has come under broad criticism, however, that it has arrived late to the e-cigarette party, an area identified as the next major growth market for the tobacco industry.

Imperial Tobacco purchased China’s Dragonite International — a leading expert in the e-cigarette field — earlier this year, and plans to launch its first suite of products as early as next year. Still, the business has been accused of failing to fully realise the potential of this market, and currently lags behind its rivals in terms of innovation and investment.

Check out that yield

Imperial Tobacco is very much the part when it comes to being a dividend-rich tobacco pick, having implemented broad double-digit annual payout rises over the past five years.

And City brokers expect the dividend to continue rolling, with last year’s 116.4p per share payment anticipated to rise to 127.4p in the year ending September 2014. This would translate to a dividend yield of 5.2%, far above the prospective average of 4.2% for industry rival British American Tobacco.

An attractive share selection

I bought shares in Imperial Tobacco earlier this year due to its qualities as a reliable dividend stock. Share prices have ducked since then, and the firm currently deals on a miserly forward P/E multiple of 10.9 versus a corresponding reading of 15 for British American Tobacco. In my opinion this is a snip, and I reckon that Imperial Tobacco’s significant restructuring drive — not to mention increased focus on its revenue driving key brands — should thrust earnings higher in coming years.

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> Royston owns shares in Imperial Tobacco Group, but does not own shares in British American Tobacco.