Imperial Brands shows defensive power

The share price performance of the big beasts of the tobacco world over the past 12 months has proved the defensive argument for the sector in sheer return terms. While much of the rest of the stock universe has been pushed into the red, British American Tobacco (BATS) and Imperial Brands (IMB) have outperformed, with their shares up by a fifth and 27 per cent, respectively.

The market’s response to Imperial’s full-year results was more muted, with the shares marked up by 1 per cent in early trading. First, the plus side. A standout was the free cash flow, which was up 68 per cent to £2.6bn – £500mn higher than had been forecast by analysts. This drove a £900mn reduction in net debt, the size of which has been a long-standing concern, and this helped the company hit its leverage target. Next-generation product (NGP) revenues grew by 11 per cent, aided by heated tobacco market launches in Portugal, Hungary and Italy, and combustibles grew market share by 35 basis points, its first gain in over five years. Encouraging stuff.

On the other hand, the slight statutory revenue fall was driven by a weaker euro. The exit from Russia and connected markets pulled pre-tax profits downwards. And profits in the first half of this new financial year are expected to be flat against last year, with performance weighted to the second six months, but the company expects a 5 to 6 per cent tailwind over the year from currency movements, with net revenue growth in the low single digits.  

So, that’s the deal with the financials. But of course it goes without saying that the other side of the investment discussion on the tobacco companies is the negative impact of their traditional products on health and wellbeing. For its part, Imperial’s “most material environmental, social and governance (ESG) priority remains consumer health”. But with concerns also growing about the health and social impacts of vaping, there is much to ponder here.

JPMorgan Cazenove analysts forecast "a double-digit medium-term earnings per share compound annual growth rate driven by more targeted NGP investment and continued tobacco margin expansion, along with a sizeable boost of share buybacks”. The shares trade at just seven times Barclays’ 2023 earnings forecast, an undemanding rating. There is enough here to support an upgrade for the investor keen on a defensive option and willing to stomach ESG concerns, but that comes with significant caveats. Hold.

Last IC view: Sell, 1,789p, 17 May 2022