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I’d buy Imperial Brands’ shares today, despite its challenges

The Imperial Brands (LSE: IMB) share price has had a good start in 2019. However, it is still way off its longer-term potential. To put this in perspective, its average share price in 2019 so far is 8.5% less than its five-year average price. And this is despite the fact that the company operates in the consumer defensives sector, which I believe, should ideally have seen a sharper uptick during the present time of Brexit driven macro-economic uncertainty.

That makes it a curious case, which needs to be unravelled to figure out if this is a worthwhile investment or not.

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Seismic shifts

Last month I wrote about sweeping changes that are under way for the tobacco industry (such as an increasing regulatory clampdown and shifting consumer preferences) in the context of British American Tobacco. This is one potential set of reasons for Imperial’s share price underperformance. The big question now is whether a seamless transition from cigarettes to next-generation products (NGP) is possible. This is a critical point to consider especially as here at the Motley Fool, we are interested in long-term investment opportunities.

The answer is not clear at present, however. Regulatory changes will take some time to take effect and evolution of consumer preferences is still at an early stage. That is especially so in many emerging markets. In the company’s own words: Tobacco will be our core business for many years to come, generating the funds to invest in NGP. But over time that balance will shift and you will see NGP making a material and sustainable contribution to our financial delivery…”

While I think investors should continue to brace for more dips in the share price going forward on news regarding these long-term changes, I believe the overall situation generally remains to the company’s benefit, ensuring continued growth through traditional tobacco products.

Debt’s a concern

There is another cause for long-term concern, though, in the form of net debt levels at 2.9x earnings before interest, taxation, depreciation and amortisation (EBITDA). To be fair, the ratio has been consistently declining for the past few years. But I am uncomfortable about the fact that it remains high. I am guessing that this concern is not far from investors’ minds either, hence the weak share price.

Stable financials steady the ship

Continued strong financial performance, can temper these concerns to a great extent. Revenues increased by 1% in 2018, despite a decrease in tobacco volumes. Operating profits also increased, aided by cost controls. The company also has strong cash flow that adds to financial stability and the company maintains a positive outlook for 2019.    

Multiple positives

Even if Brexit impacts the UK’s economy, Imperial is likely to be insulated to a certain extent as it is a consumer defensive company, which sees consistent demand. And it is a global company with half its revenues coming from outside the UK, so it is perhaps no surprise that most city analysts have a buy rating on the stock. I tend to agree with them, despite the long-term smoking trend decline!

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Manika Premsingh 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.