Thursday 8 January 2015

BUY: Imperial Tobacco--Growth within a Declining Industry?

Price: 2817.51
Shares: 21
Predicted annual dividend income: £29.44

Resolutions for the New Year are being passed on everywhere at the moment. For obvious reasons. One of the most common I have encountered amongst my friends and colleagues has been "Give up smoking." That's nothing new. Across the country there are probably millions of people saying the same thing (indeed, with many having made the same resolution innumerable times before).

I am not a smoker. However, I have taken a different resolution at the start of this year. Rather than giving up smoking I have--surprisingly--taken it up. Not the actual process of buying tobacco and smoking it, but investing in a tobacco giant. On this occasion, Imperial Tobacco.

Quality Company

Imperial Tobacco is a genuinely quality company. As well as having a market cap of around £27 billion it has an effective management team and a remarkable record of growth even in an industry broadly understood as in structural decline. After all, the percentage of the global population smoking is in decline (of course, due to population growth, the number of smokers continues to grow across the globe).

However, the industry does seem to be consolidating as the tobacco giants start to gobble up one another. Indeed, one such deal between Reynolds American and Lorillard has made Imperial even more attractive. The merger between them will require the sale of some of their joint assets of which Imperial came out to purchase. As well as a number of appealing US brands they included the Blu vaping brand as well. All in all, the deal seems a very good one for Imperial.

So how do the figures line up?

P/E Ratio

Perhaps due to the "sin" stock nature of tobacco companies they seem to be perpetually running at a discount to other consumer defensive companies. Certainly, Imperial is not currently overly priced. For example, for this year they anticipate these EPS and P/E figures:

EPSP/E Ratio
Difference (%)19.81

Even assuming the lowest predictions we see a P/E below 15. For a consumer defensive company this is too tantalising for me.

What is more, this is not expected to be reversed in the near future. For the year after we see modest growth continuing.

EPSP/E Ratio
Difference (%)26.20

Again, even assuming the lowest analyst prediction we have a P/E of just over 14. Again showing that Imperial represents a very fair value for a reliable consumer performer.

Dividend Growth

Of course the main reason for investing in tobacco companies is their yield. This is the same case with regards to Imperial Tobacco. Not only does it have a current yield of about 4.5% but it is predicted to see a continued dividend growth of c.10% for the foreseeable future.

It is expecting to see a dividend of 140.18p and 154.11p for the next two years. This would churn out a mighty 4.98% and 5.47% respectively. This is a very impressive yield from a consumer defensive company such as Imperial.

What is more, the cover is by no means wafer thin. It is anticipated that for this year the cover will be about 1.5 times earnings with this dropping to about 1.45 times earnings the year after.

For a consumer defensive company of this sort a cover of about 1.5 times earnings is pretty commonplace. Unilever run one around the same level, as does Next and--more relevantly--so does British American Tobacco.


On other metrics Imperial also looks quite interesting. Certainly in some regards it is less so. Debt to equity is running at about 1.99. Again, this is not overly concerning with the consistent earnings profile Imperial presents. 

This is even more the case as we can see from the balance sheets that they have (since 2010) brought down their debt to some extent as well as growing their cash reserves. Of course, this trend is likely to be reversed with the Reynolds Lorillard deal. But it shows good intentions if nothing else.

Imperial and my Goals

So where does Imperial sit within my goals for the year? Nicely indeed. First, clearly the yield should help  me reach my goal of a portfolio yield of 4% or more. What is more, with a predicted income for next year of £29.44 it contributes generously to my £800 dividend income target for 2015.

Similarly, with a Beta volatility value of 0.4629 it makes a very positive contribution to my target or getting a portfolio Beta value lower than 0.85.

Overall, I am very happy with Imperial as it contributes nicely to my portfolio going forward and manages to act as a positive influence on all of my goals for this year. 

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