Stockwatch: A 7% yield plus double-digit dividend growth

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Stockwatch: A 7% yield plus double-digit dividend growth

At 2,780p, has FTSE 100 (UKX) tobacco stock Imperial Brands (IMB) bottomed out after a 43% slide in the last two years, making its bumper yield a bargain?

Do advances in e-cigarettes/vaping offer growth to help offset the sense of tobacco as ex-growth?

How does Imperial Brands compare versus British American Tobacco (BATS), itself down about 35% in only the last year?

BAT has risen 6.5% off its recent low, but Imperial is the twitchier, up 19% from what could have been a "double bottom" on its chart during March and April.

Interim results trigger buying interest

Imperial's rebound is being helped by "less worse than expected" interims to end-March 2018: overall flat revenue of £14 billion, no disappointments by way of product sales, and a 6.2% slip in normalised earnings per share (EPS) to 114.3p, which beat consensus for 111.9p.

Management appears to have a better grip on things, now investing in new consumer demand for e-cigarette/vapour products (see if not smell how fashionable they in urban centres) and divesting the group's more fragmented businesses.

Thus, with cash flow strengths appearing so far to support the board's aim for 10% annual dividend growth, the stock's risk/reward profile may now be tilting positively.

Short-selling does not appear to have accentuated the fall/rebound: Imperial has no recent history of disclosed short positions over 0.5%, i.e. the stock dynamics imply a genuine inflection point for sentiment.

Time will tell whether that applies to fundamentals also, but signs look overall encouraging for the first time in a good while.

Imperial offers a 7% yield versus BAT on 5%

Historically BAT has tended to beat Imperial in terms of narrative/fundamentals, hence the market pricing BAT for a slightly lower yield with regard to financial risk.

Margins and debt are key differentials: BAT enjoying an operating margin of 31.9% (and rising) versus Imperial's stubborn around 9%. Meanwhile, BAT's total net debt has jumped 58% to £45.6 billion for gearing of 75%, versus Imperial's results showing long-term debt, down 16.9% to £9.7 billion while short-term debt has risen 22.8% to £3.4 billion, i.e. gearing of 232% on net assets of £5.4 billion.

Mind how both balance sheets are swollen by intangibles, £18.9 billion for Imperial.

Thus, one reason both stocks have de-rated (BAT down 35% from a mid-2017 high) is management's use of debt during the era of ultra-low interest rates. However, the market has seen through this to anticipate rates rising.

Imperial's interims show net finance costs around £250 million taking a chunk out of £833 million operating profit, although an adjusted operating profit of £1,624 million is shown after writing back amortisation and exceptionals (restructuring and a UK distributor going into administration).

So, be aware of potentially rising debt costs albeit mitigated if Imperial achieves £2 billion planned disposals in the next 12 months, with proceeds partly to be applied to cut debt.

Imperial Brands - financial summary           Consensus estimates
year ended 30 Sep 2013 2014 2015 2016 2017 2018 2019
Turnover (£ million) 28,269 26,460 25,289 27,634 30,247    
IFRS3 pre-tax profit (£m) 1,219 1,525 1,756 907 1,861    
Normalised pre-tax profit (£m) 2,073 1,944 2,169 1,257 2,276 2,510 2,714
Operating margin (%) 9.4 9.1 9.9 8.0 9.0    
IFRS3 earnings/share (p) 92.7 148 177 66 147    
Normalised earnings/share (p) 180 192 211 103 191 271 279
Earnings per share growth (%) -10.3 6.4 9.8 -51.3 85.8 42.2 3.1
Price/earnings multiple (x)         14.6 10.3 10.0
Historic annual average P/E (x)   13.7 16.3 22.7 30.5 14.3  
Cash flow/share (p) 189 206 241 274 265    
Capex/share (p) 29.0 29.1 19.3 19.8 23.0    
Dividend per share (p) 109 120 132 145 160 188 207
Dividend yield (%)         5.8 6.8 7.4
Covered by earnings (x) 1.7 1.6 1.6 0.7 1.2 1.4 1.4
Net tangible assets per share (p) -1,216 -1,073 -1,396 -1,606 -1,474    

Source: Company REFS                  Past performance is not a guide to future performance

A better second-half year to 30 September?

The sense of an H1/H2 imbalance for Imperial has been in the market since last November's prelims cautioned that 2018 would be H2-weighted amid tough industry conditions.

The H1 income statement shows that after flat overall revenue and a slight rise in duty trimmed gross profit, containing administrative/other costs limited the operating profit slip to 7.6%. Then further down the statement a 32.5% reduction in investment income means pre-tax profit slid 25.4% to £600 million.

"Within a tough but improving environment, we exited the first half with much stronger price/mix and expect to convert our improved share into top-line growth in the second half."

Product-wise, cigarette volumes have slipped 2.1%, but the industry average is -5.7%, and Imperial's growth brands have risen from 45.3% of last year's net revenue to 49.1% in H1 2018.

Multiple new product launches are heralded and there is particular optimism for "myblu", a said "quality vapour experience" to boost H2 sales onwards.

Its US launch saw online orders rapidly sell out, with a similar launch being finalised for France, the UK, Germany Russia, Italy and other countries by end-September, then to double the number of its markets from at least 10 to 20 in the 2019 financial year.

But mind as regards profits, Imperial's annual price-rise target of 4%-5% implies as much as an 8% hike being required in H2, in a context of wider margin pressures within the industry.

Using the company's total adjusted operating profit figures, the like-for-like H1 margin has slipped from 12.2% to 11.4%.

Thus, near-term EPS may be in a dilemma, down 6.2% in H1 to 114.3p on an adjusted basis and by 1.0% at constant currency: there's plenty to catch up in H2 to meet the 271p full-year consensus, if the REFS table is accurate.

I'd be a tad sceptical of "42.2% EPS growth" given investment bank Jefferies cites 9% growth in H2 EPS being required to meet its low-end expectation. Weaker sterling may help after H1 strength meant a 3% headwind to revenue/profit.

More positively, cash conversion over 90% of operating profit supports 10% annual dividend growth, which ought to support the stock around current levels.

The £2 billion disposals should also underwrite this payout policy, besides generating funds for investment and streamlining the group, thus increasing takeover appeal.

Finance director buys £70,375 worth of shares

On the interim results day he bought at 2,764p, which follows two material purchases of shares by insiders at end-March, just before Imperial entered its closed period: the research director 3,000 shares at 2,382p; also the strategy director's wife 10,000 shares at 2,321p; together with two smaller buys and the chief executive exercising options, selling only what was needed to pay tax.

This amounts to a definite aspect of cluster buying which looks bullish.

It doesn't appear to concern the finance chief though, how in addition to high debt/intangibles, the balance sheet shows trade payables nearly three times trade receivables, versus a ratio of 2.2 times at BAT. So mind another aspect of balance sheet stretch.

Thus, I derive a net bullish conclusion, albeit with near-term risks as regards the full-year 2018 outcome.

Yield supports market price and Imperial's marketing act is responding well to a big global opportunity in the shift from tobacco to vapour.

The stock could therefore be establishing an upwards-if-volatile trend, so keep watching for opportunities. Accumulate.

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