When I think of cigarette and tobacco producer Imperial Tobacco Group (LSE: IMT) (NASDAQOTH: ITYBY.US), two factors jump out at me as the firm’s greatest weaknesses and top the list of what makes the company less attractive as an investment proposition.
1) Declining revenue
Volumes have been on the wane for some time in the cigarette and tobacco industry. Apart from the obvious trend of people moving away from smoking in the developed world as health-awareness digs deeper with each new generation, in the EU, austerity measures, unemployment, competition from illicit trade, and tough regulation on advertising, are all factors affecting general tobacco-product sales. Imperial Tobacco is also seeing weakness in some of its other main markets, such as Russia. It reveals much to see that volumes in Imperial’s ‘growth-brand’ category recently declined 2% compared to the year-ago figure.
It’s plain to see how Imperial Tobacco is struggling with its revenue figures when we look at the firm’s recent record:
| Year to September | 2009 | 2010 | 2011 | 2012 | 2013 |
|---|---|---|---|---|---|
| Revenue (£m) | 26,517 | 28,173 | 29,223 | 28,574 | 28,269 |
2) Declining dividend cover
With revenue starting to slip, Imperial has been targeting cost reduction measures and raising end-product prices to squeeze out more cash flow and profit. However, looking at the table below, it seems clear that profits are not keeping up with the rising dividend, as cover from earnings is declining. Sooner or later, something must give if the top line continues to deteriorate, such as the dividend either halting its progression or even being trimmed in size to adjust to the firm’s shrinking business.
| Year to September | 2009 | 2010 | 2011 | 2012 | 2013 |
|---|---|---|---|---|---|
| Adjusted earnings per share | 161.8p | 178.8p | 188p | 201p | 210.7p |
| Dividend per share | 73p | 84.3p | 95.1p | 105.6p | 116.4p |
| Divided cover from earnings | 2.2 | 2.1 | 1.98 | 1.9 | 1.8 |
In the meantime, the firm is doing all it can to bump up returns by buying back its own shares, which induces a nicotine-like rush in earnings- and dividend-per-share figures, but hopping on this smoking-seats-only train feels like a race to collide with the buffers at the metaphorical end-of-the-line.
What now?
Imperial Tobacco’s 5.3% forward dividend yield doesn’t appear as attractive to me as the income available from some other companies.