Five Ways Imperial Tobacco plc Could Make You Rich

imtImperial Tobacco (LSE: IMT) (NASDAQOTH: ITYBY.US) offers a heady yield, but recent growth has been short of flavour. Here are five ways it could still make you rich.

1. By being undervalued.

Imperial Tobacco’s recent performance has been underwhelming. Its share price is up just 23% over five years, half the 55% enjoyed by the FTSE 100. It is down 15% over the last 18 months as “austerity measures, unemployment and illicit trade” hit EU volumes. Adverse regulatory and excise charges in Russia haven’t helped. That said, this does reduce the entry price. IMT now trades at just 10.5 times earnings, compared to rival British American Tobacco’s pricier 14 times earnings.

2. By controlling costs.

Smoking is in long-term decline in the developed world. As smokers become an embattled minority, politicians will feel free to squeeze their rights even further (plain packs are the next step). Developing nations look set to follow suit — witness the proposed Chinese ban on smoking in public places. Imperial Tobacco is running a successful “cost optimisation programme” to limit the damage caused by flat or falling volumes. It delivered £30 million of savings in 2013, and that should rise to £300 million a year to September 2018. That helped it lift profits by 1% last year.

3. By outpacing the market.

In a tight market, you have to beat your rivals. Imperial Tobacco has been doing that. Excluding China, its volumes fell just 2%, half the 4% decline in the wider market. It has been boosting market share thanks largely to its growth brands, led by star performer JPS, and a strong presence in high-growth segments such as queen size, slims and additive free. Its new stand-alone subsidiary, Fontem Ventures, should help it play catch-up in the fast-growing $2 billion e-cigarette market. A strong balance sheet helps. As does an impressive 93% cash conversion rate. Not to mention a return on capital employed of 120%.

4. Slowly but steadily.

Nobody expects Imperial Tobacco to light up the FTSE 100 (although at today’s reduced valuation, there is some scope to make up recent lost ground). It is more of a slow-burner. Earnings per share looks set to rise just 1% in the year to September 2014, although that should increase to 5% in the subsequent 12 months. This should knock the p/e down to just 9.9 times earnings by September 2015. There is plenty more Imperial Tobacco can do to protect profits, such as hiking prices and breaking new ground in emerging markets.

5. By handing you cash.

The main way Imperial Tobacco will make you wealthy is its smokin’ dividend. Right now, it yields 5.3%. Better still, management has declared that it aims to raise the dividend by at least 10% a year over the medium term, a pledge it met last November. The yield is forecast to hit a mighty 6.3% by September 2015. Not only that, but Imperial Tobacco bought back shares to the value of £500 million last year. If you’re happy investing in tobacco stocks, the recent share price fall could make now a tempting time to buy into a high and rising income stream. 

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Harvey Jones doesn't own shares in any company mentioned in this article.