Learning The Hard Way: Imperial Tobacco Group plc And AstraZeneca plc

It is decision time for shareholders of Imperial Tobacco Group (LSE: IMT) and AstraZeneca (LSE: AZN) (NYSE: AZN.US). What do they have in common? As M&A talk fade away, these equity investments show clear signs of distress. Read on…

AstraZeneca: More Downside 

It takes a huge leap of faith to remain invested in Astra these days. The company isn’t likely to deliver growth for a couple of years, although Astra says its revenue growth will outpace that of competitors in the next decade.

A Footsie-beating dividend yield of 4% is not enough to render Astra stock an appealing buy in the current market. Indeed, its shares look overvalued based on forward trading multiples for cash flow and earnings. 

In mid-July I noted that ever since takeover talk vanished, Astra had struggled to create value, adding that Astra shareholders wouldn’t get the deal they had hoped for. The stock has lost about 4% of value in five weeks of trading and is on its way down to the end of the year, in my view.

When volatility surged in recent weeks Astra stock came under pressure, and I think downside of more than 10% is apparent, particularly if trading conditions get tough. And if volatility remains subdued, I don’t expect a market-beating performance to the end of the year.

It’s unlikely that Astra shareholders will be able to record a massive paper gain without a bid from Pfizer, and it’s conceivable that Pfizer will look elsewhere in weeks ahead. Astra shares still trade about 19% above Astra’s unaffected share price of £35.8 on 3 January.

Imperial Tobacco: A Dividend Play 

Imperial Tobacco reported interim results on Tuesday. Its shares rose 2.2% on the day, outperforming the broader market by more than one percentage point. The results made for a decent reading, but I was not impressed. Growth sputters, and that’s a big problem for Imperial shareholders. 

Imperial stock have lost 5.8% of value from the all-time high it recorded in mid-July.  

The rise in Imperial’s equity valuation, which was spurred by takeover rumours earlier this year, came as investors decided to bet on Imperial as soon as it became apparent that consolidation was back on the agenda in the tobacco industry. Without a takeover — which is unlikely to take place — the stock of Imperial won’t be a winner in the next six months, in my view. 

Moreover, I think Imperial is a more appealing leveraged-buyout target than a takeover candidate for trade buyers. Taking it private for four years would make a lot of sense, but would require a substantial equity financing of up to 50% of the purchase price. If anything, Imperial’s latest nine-month results show that it may become more difficult for other players in the industry to meet estimates. 

In fact, guidance for the year continues “to be modest adjusted earnings per share growth” at constant currency, the group said. Imperial is a dividend play, given that it promises a dividend growth of at least 10%.

Much of its fortunes, however, hinge on a cost cutting programme which is forecast to deliver additional savings of £60m annually. In a tough regulatory environment for tobacco, nicotine and related products, this is how value will be pursued in the next few quarters.