Monday, 15 June 2015

Imperial Tobacco: slow versus fast capital

I spent part of this afternoon (UK time) listening to the Imperial Tobacco webinar on its recent US acquisitions.  The company has been a solid pension fund holding of mine for a while now and I augmented the position last summer (as I detailed here) on the announcement of a deal to buy US tobacco brands being forcibly divested to appease regulators concerned about the competition impacts of the Reynolds-Lorillard merger.   

Often it is the case that it is better to travel than arrive and that has been true of Imperial Tobacco shares over the last year which following my linked observation above have performed rather well.

But now it is time for delivery on the newly acquired US businesses. Even acknowledging problems around ISIS and illegal cigarettes (link here) the company has been performing with great solidity - and a 4.5%+ dividend with anticipated 10% progression always helps.  Nevertheless deal hopes reflect the new marginal pieces of information. 

The initial observations sounded positive: 

‘from number five in the market…we are now a clear number three’

'on a pro forma basis the US was 20% of operating profits'

‘strongly cash generative…support dividend payment and debt production’

‘currently looking at refinancing opportunities…will keep you posted’

And the affordability of US cigarettes is stunning...

However...then management observed that this was ‘not a deal built on the need to reduce costs’.  Now there is nothing wrong with this at all.  Imperial Tobacco's newly integrated US unit has a c. 9.5% market share of the US cigarette market currently and the initial aim will be to stabilise this - reflecting from their perspective a lack of recent historic marketing spend on national US brands like Winston and Maverick' before aiming to grow market share.  Any synergies generated - normally an important component of any consumer staples deal - will be reinvested into such marketing spend augmentation.  

This is sensible stuff - even if much of the market share growth is likely to come from downtrading and taking share off other ‘value’ brands.  On a multi-year view Imperial Tobacco should be good custodians of these newly acquired brands (which include a fast growing - albeit small - e-vapour offering called Blu).  

So no huge headlines and not a huge cost slashing deal but a revitalisation of brands one. Watching the cigarette market share proportion is clearly going to be a new hobby for Imperial Tobacco brokers/investors and this is the first guide as to how the plan is unfolding...whilst medium-term it is all about getting the marketing dollars to work. And there is no pressure on the aforementioned dividend (all the main rating agencies have updated their numbers and remain supportive of the prevailing credit metrics).  

A low teens prospective multiple is not exactly cheap however. My view is that Imperial Tobacco shares were an easier call when the deal was announced (at a substantially lower share price as shown on the share price chart above) as a positive opportunity but here in the lower £30s much feels priced in and proving up on the US is going to take a year or so with market share stabilisation the key.

So no fire and the share is a hold/pick up the dividend and my feeling is sub £30 you buy (more) of the shares. Faster money may however find more compelling 3-9 month time duration opportunities (and hence look to top-slice) even in a volatile market which traditionally would support tobacco sector investment.  

So what you do with any Imperial Tobacco holding is whether you are slow or fast capital.  No need to rush to change my pension fund holding but for faster capital I would top-slice now and buy back sub £30.  

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