The Surprising Buy Case for Imperial Tobacco Group plc

Today I am looking at how galloping demand for e-cigarettes is set to drive revenues at Imperial Tobacco Group (LSE: IMT) (NASDAQOTH: ITYBY.US) higher.

e-cigarettes set to drive earnings skywards

Shares in tobacco play Imperial Tobacco have endured extreme turbulence in 2013, the stock conceding 6.5% in the year to date so far as stalling cigarette demand across the globe has sapped investor appetite.

While it is true that tobacco demand has slowed in recent times — particularly in emerging regions, responsible for around four-fifths of total consumption — Imperial Tobacco’s move to harness surging demand for e-cigarettes is set to pay off handsomely in coming years.

Online e-cigarette retailer V2Cigs announced this year that sales of e-cigarettes have now breached the $1bn per year marker. And citing broker Wells Fargo, the outlet notes that total sales in 2013 are likely to hit $1.7bn in 2013, surging from $500m in the prior 12-month period.

Conservative data indicates that traditional electronic cigarette retail sales on an annualised basis is $700m,the broker notes.When combined with online sales, the industry has now exceeded $1bn for the first-time ever, with the consumption of e-cigs likely surpassing that of traditional cigarettes in the next decade.

Imperial Tobacco has been busy in its bid to latch onto the surging market for these electronic alternatives, as the effect of a more health-conscious populace, increased tobacco duties and introduction of plain packaging have eroded consumption of its traditional products.  Indeed, group stick sales slumped 7% to 317bn in the 12 months to September, the firm advised in November.

Indeed, the business recently bought out Chinese e-cigarette developer Dragonite International, which holds a gaggle of patents covering the fledgling market, to boost its position at the coalface of new technologies in this exciting market and enhance its product range over the long term. The tobacco giant is planning to launch its maiden e-cigarette in the coming months.

Still, City analysts expect Imperial Tobacco’s earnings to edge 2% higher in the year ending September 2014, to 215.7p per share, as doubts over near-term cigarette demand hamper near-term revenues projections.

But over the long term, I am convinced that Imperial Tobacco is ready to record bumper earnings expansion. Not only should stratospheric growth rates in e-cigarettes boost revenues in coming years, but I believe that recovering consumer spending power — particularly in developing regions — should drive demand for traditional sticks higher once more.

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In line with its improving earnings prospects, I expect Imperial Tobacco to provide increasingly-generous dividends to its shareholders. The firm is a long-standing favourite among payout seekers and currently carries a meaty 5.6% yield for 2014.

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> Royston owns shares in Imperial Tobacco Group.