Imperial Brands Group (IMB) Ordinary 10p

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Last year, Imperial Brands grew underlying Tobacco and Next Generation Product (NGP) revenue by 4.6% to £8.2bn. This was driven by 26% growth in NGP sales and strong pricing in tobacco which offsets a 4% decline in volumes.

Underlying operating profit grew by 4.6% to £3.9bn, in line with prior group guidance.

Free cash flow was flat at £2.4bn. Underlying net debt fell from £8.0bn to £7.7bn.

The annual dividend was raised by 4.5% to 153.42p per share. The ongoing £1.25bn buyback is expected to be largely completed during this financial year.

This year’s tobacco and NGP net revenue is expected to grow at a low single-digit pace. Underlying operating profit is expected to grow in the mid-single digits.

The shares were up 3.0% following the announcement.

Our view

Imperial Brands’ full-year results extended its track record of reliable profits and strong cash flows. The focus on tobacco markets, where it sees the scope to grab market share, is helping it paint a brighter picture than some of its competitors. Volume pressures have also been easing in some of these markets. The nature of selling an addictive product means Imperial's been able to put through big price increases. When combined with impressive cost savings, profits are still growing steadily.

But tobacco companies can't fight against the tide forever. Regulatory pressure and changing consumer preferences towards healthier lifestyles means we think there will be further challenges ahead.

That's why the entire industry's jostling for position in the up-and-coming Next Generation Products (NGPs) market, including products like heated tobacco and vapes.

It's not been an easy start for Imperial, and while a more focused approach to the NGP portfolio is starting to bear fruit, these products are still a relatively small part of the picture and are yet to turn a profit. It's too early to say if they can be a viable replacement for the shrinking tobacco business. First, we will need to see several years of high double-digit growth and demonstratable evidence of sustainable profit margins. Another risk to the success of NGPs is the increasing attention they are receiving from regulators.

Cash generation has impressed consistently. That’s supporting generous distributions to shareholders and investment in new products while keeping net debt below Imperial’s target range of 2.0-2.5 times underlying cash profit (EBITDA).

We think shareholder distributions are an attractive part of the investment case, but could be sensitive to a deterioration in volumes if the decline in tobacco usage accelerates. The shares offer a prospective dividend yield of 6.8% and Imperial intends to complete most of the ongoing £1.25bn share buyback in the current financial year.

All else equal that should provide further support to help both the relative valuation and the prospective yield. As long as forecasts are met, this level of shareholder distributions should be largely covered by free cash flow. But no shareholder returns can ever be guaranteed.

Despite improved sentiment towards the shares, Imperial’s valuation lies towards the bottom of the peer group, a position that we see as somewhat unwarranted. On top of the attractive yield, there’s also some growth potential if it can make progress in its priority markets and execute on the NGP roll out. But with the industry still facing an uncertain future, negative publicity remains a risk to be mindful of.

Environmental, social and governance (ESG) risk

The food and beverage industry tends to be medium-risk in terms of ESG though some segments like agriculture, tobacco and spirits fall into the high-risk category. Product governance is a key risk industry wide especially in areas with strict quality and safety requirements. Labour relations and supply chain management are also industry-wide risks, with other issues varying by sub-sector.

Imperial Brands’ overall management of ESG issues is strong according to data by Sustainalytics, but we have some concerns. The company has stressed its commitment to offer smokers a choice of potentially less harmful products. However, in 2023 next-gen products made up just over 3% of net revenue. The company is also involved in moderate controversies related to business ethics (including child labour and employee exploitation in the supply chain), marketing practices, and the social impact of its products.

This article is original Hargreaves Lansdown content, published by Hargreaves Lansdown. It was correct as at the date of publication, and our views may have changed since then. Unless otherwise stated estimates, including prospective yields, are a consensus of analyst forecasts provided by Refinitiv. These estimates are not a reliable indicator of future performance. Yields are variable and not guaranteed. Investments rise and fall in value so investors could make a loss.

This article is not advice or a recommendation to buy, sell or hold any investment. No view is given on the present or future value or price of any investment, and investors should form their own view on any proposed investment. This article has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is considered a marketing communication. Non-independent research is not subject to FCA rules prohibiting dealing ahead of research, however HL has put controls in place (including dealing restrictions, physical and information barriers) to manage potential conflicts of interest presented by such dealing. Please see our full non-independent research disclosure for more information.

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