Over the past 10 months, the share price of cigarette maker Imperial Brands (LSE: IMB) has fallen a little over 30%. However, the financial fundamentals of the business appear to be sound.
I think an interesting situation is developing because Imperial Brands remains a defensive investing proposition, but the valuation is falling to lower levels that we haven’t seen for years. At today’s share price around 2,659p, the price-to-earnings rating for the current trading year is just over 10 and the dividend yield a little over 7%. Something must give. Either the share price will stop falling soon, or…
I think an interesting situation is developing because Imperial Brands remains a defensive investing proposition, but the valuation is falling to lower levels that we haven’t seen for years. At today’s share price around 2,659p, the price-to-earnings rating for the current trading year is just over 10 and the dividend yield a little over 7%. Something must give. Either the share price will stop falling soon, or the financial quality of the underlying business will surely deteriorate, proving the market right in marking down the stock.
Trading as expected
Wednesday’s pre-AGM trading update revealed that the firm is on course to meet revenue and earnings expectations for the year. City analysts following the firm predict earnings will dip 3% for the trading year to September 2018 and to rise 6% the year after that. The directors told us that they expect a strong performance in the second half of the year and that the firm’s growth brands and priority markets are delivering gains following a programme of marketing investment last year. They described volume growth as “robust”, which translates into ongoing gains in market share.
But there are challenges. The European Union Tobacco Products Directive, and excise increases in France, have caused the company to change its product mix leading to a reduction in pricing. However, to offset this assault on profits, the firm is “significantly stepping up” efforts to build its business in next-generation products with “multiple launches” over the next few months. E-vapour growth is a priority, such as the blu brand, which is selling in the US, UK, France and Italy. The company aims to drive the growth potential in those markets and to push blu into other markets, too. On top of that, the firm is trialling heated tobacco products in Europe and Japan.
Profits set to improve
As well as growth from these next-generation products, the company expects tobacco sales to grow during the year. Constant currency net revenue looks set to benefit from market share gains in the company’s priority markets and improved pricing. So any weakness in the trading figures we are seeing now should reverse as the firm’s mix of products and pricing becomes more profitable again.
Imperial Brands remains a fast-moving consumer goods enterprise with stable and predictable inflows of cash ideal for paying out consistent dividends. As well as the effects of a resurgent pound, I think the firm has been caught up in a general fall in the valuations of such defensive firms lately, driven by what looks like a rotation of investors out of expensive-looking defensives into cheaper-looking cyclicals. Rising interest rates could also be driving valuations down a little in anticipation of the ‘bond-proxy’ trade in defensives unwinding because returns are likely to become attractive in other assets such as bonds and bank accounts.
But whatever the general market dynamics, Imperial Brands’ underlying business doesn’t become less attractive just because the share price has gone down. I reckon the company’s new generation initiatives and continuing market share gains with its traditional products will continue to keep the cash taps flowing and the dividends rolling out for years to come.
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Kevin Godbold has no position in any of the shares mentioned. The Motley Fool UK has recommended Imperial Brands. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.