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Imperial Brands has the brands

Imperial Brands has the cash headroom to keep its payout rising
July 14, 2017

Dividend policy: Imperial Brands is committed to continuing to grow its dividend by at least 10 per cent a year over the medium term.

Yield: 4.7%

Payment: Twice a year, declared and paid in sterling

Last cut: The dividend has only ever gone up since the company was spun out of Hanson and listed on the FTSE 100 in 1997

IC TIP: Buy at 3460p

The beginning of this month marked the 10-year anniversary of the UK’s ban on smoking in enclosed workspaces, giving investors in tobacco companies pause for thought on how the sector has fared since the rule took hold. 

Imperial Brands (IMB) has not been immune to the global industry challenge of declining volumes as health scare adverts encourage more smokers to stub out, and treasuries push up taxes. Over the six months to March 2017, Imperial sold 126bn stick equivalents, down from 134bn in the same period in the previous year. This could make investors nervous that the company may not be able to keep true to its commitment to increase its dividend by at least 10 per cent each year over the medium term, a promise they have so far kept for eight consecutive years. 

But despite this fall in the number of cigarettes sold, Imperial Brands managed to deliver a 12 per cent increase in revenue to £14.2bn for the same period and increase pre-tax profits by 78 per cent to £804m. A cost optimisation programme has helped. The company is on track to deliver £300m in cost savings by the 2018 financial year, and is targeting a further £300m by FY 2020 by reducing complexity and making the business more efficient. The goal looks as though it will certainly be achievable in that timeframe, given progress made so far. 

The £300m that Imperial aims to save will be used to invest in the growth brands, including Davidoff and Gauloises Blondes, and specialist cigarette brands including Gitanes and Kool, in the markets that the company feels present the best opportunities for growth, such as Russia and Saudi Arabia. Getting consumers to buy its pricier products will help to offset the decline in volumes, the theory goes, and the better quality of these products could make it more likely that those customers will come back for more.

Cash conversion (of operating profits into operating cash flow) stood at 99 per cent at the half-year, an improvement from 95 per cent at the full year, which will help the company keep its dividend promise, as will the earnings cover for the dividend. Bloomberg’s consensus forecast is that earnings cover will be 1.6 for the year to September 2017, the same as last year, but falling to 1.5 in FY2018, and 1.4 in FY2019. The nature of tobacco sales means that cash flows can be volatile, but the Imperial payout would only come under threat if the board felt it could not rely on future cash flow. This seems remote: even after the demands of capital expenditure and dividends paid, the company has comfortable headroom of more than £1bn.

If Imperial Brands can’t sell as many cigarettes as it used to, then it will have to innovate to make sure that it stays relevant to consumers’ changing tastes. Imperial Brands’ Fontem Ventures subsidiary is focused on building the sales of its e-vapour product blu, in a market dubbed the “fastest-growing next-generation category”. Fontem Ventures is also looking at licensing a range of patented technologies and exploring other products that it feels could complement its existing offering, such as caffeine energy products. Although management was cagey about details at the half-year, they did let it slip that the company is testing a portable low-calorie caffeine-based energy product. Last month Simon Langlier, previously the chairman of Canadian medical cannabis group PharmaCielo, was appointed to the Imperial Brands board, inciting speculation that the company could consider moving into the cannabis market if wider legalisation is adopted.