It’s been a tough year for shareholders of tobacco giant Imperial Brands (LSE: IMB). The firm’s share price has fallen by about 15% to levels not seen since 2014. Although the dividend was lifted 10%, many shareholders will be sitting on losses.
Imperial’s valuation has been hit by fears that falling tobacco sales mean future growth is uncertain. With debt levels high, bearish investors suggest the company could find it difficult to protect its dividend and repay debt.
To find out whether these fears are justified, I’ve been taking a look at today’s full-year results from the firm.
Fewer, bigger brands
One technique being used by Imperial and its rivals is to focus on fewer, bigger tobacco brands. This can help to cut marketing and manufacturing costs.
Today’s figures show how this approach is working. Although the total tobacco sales volumes fell by 3.6% to 255.5bn stick equivalents, sales of the firm’s key growth brands rose 2.1% to 162.9bn stick equivalents.
Meanwhile, revenue from tobacco and next-generation product sales rose by 2.1% to £7,730m, excluding currency effects.
Profits rose, too.  Adjusted operating profit from sales rose by 1.9% to £3,557m. Imperial’s distribution business added a further £212m of operating profit, giving a total figure of £3,766m — 2.9% higher than last year.
These figures imply an adjusted operating profit of 48.7%. It’s clear that this is still a very large and profitable business.
But sales are falling…
Imperial has two plans to combat falling sales. In the short term, it expects to raise up to £2bn by selling off unwanted assets. This seems likely to include some tobacco products in mature markets.
This will help chief executive Alison Cooper to repay some of the group’s debt. Adjusted net debt remains a little high for my liking, at £11.5bn. That’s 2.9 times adjusted earnings before interest, tax, depreciation and amortisation (EBITDA), above my preferred limit of 2x EBITDA.
Looking further ahead, the second part of the company’s strategy is to become a market leader in what it refers to as next-generation products (NGP). The group’s main brand is blu, a leading vaping product.
Imperial’s size and marketing reach means that it’s well positioned to extend blu‘s market share. What’s less clear to me is the potential size and profitability of this market, which is starting to draw the attention of regulators. In today’s results, the firm said that annualised sales of blu have now reached £300m per year. Management expect the NGP business to make its first contribution to group profits in 2019.
My verdict
Today’s results show free cash flow of about £2.8bn, putting the stock on a price/free cash flow ratio of 9. That’s very cheap, and provides ample cover for the group’s dividend of 187.8p per share, even after interest costs of £501m.
The shares haven’t moved following today’s news, leaving them on a price/earnings ratio of 9.7 with a dividend yield of 7.1%. In my view that’s probably too cheap.
You may have ethical concerns about investing in tobacco stocks. I certainly do. But from a financial perspective, I believe Imperial Brands is likely to deliver attractive shareholder returns from current levels.