Morning Note: Market news and results from Imperial Brands.

Market News

US equity markets were little changed last night – S&P 500 (-0.1%); Nasdaq (-0.2%) – ahead of today’s key inflation data. The report is set to show slower progress toward the Fed’s 2% target, keeping the central bank biased toward more tightening, Bloomberg Economics said. Core CPI probably gained 0.3% month on month, leaving the year-on-year rate unchanged at 4.1%. 10-year Treasuries yield 4.63%, while gold edged up to $1,944 an ounce.

This morning in Asia, markets were mixed: Nikkei 225 (+0.3%); Hang Seng (-0.2%); Shanghai Composite (+0.3%). The yen held near its lowest level this year against the dollar. The FTSE 100 is currently trading 0.2% lower at 7,413.

The Bank of England’s Mann says climate change poses a persistent inflation threat. UK wage growth slowed, and vacancies continued to fall. Average earnings excluding bonuses rose 7.7% in the three months to September. Sterling trades at $1.2282 and €1.1474.

The oil price continued its recent recovery – to $82.85 a barrel – even though more hedge funds are shorting the commodity. Iron Ore fell as China home sales declined. Canada’s Teck Resources has sold its coal division for $9bn to a consortium of Glencore (77% for $6.93bn), Nippon Steel (20%), and POSCO (3%).

Source: Bloomberg

Company News

Imperial Brands has this morning released its results for the financial year ending 30 September 2023. The company raised its dividend by 4% and will continue with its £1.1bn share buyback programme, which together amount to a 15% capital return. In response to today’s news, the shares are little changed in early trading.

Imperial Brands manufactures and sells cigarettes, fine cut tobacco, smokeless tobacco, cigars, and next generation products (NGP). The main brands include Winston, Davidoff, L&B, West, and JPS. The group’s five-year business plan is focused on three pillars, with investment focused on markets and brands with the greatest opportunity for value creation.

The primary driver of medium-term value creation is a revitalised tobacco business focused on the group’s top five (priority) markets – US, Germany, UK, Australia, and Spain – which represent 70% of combustible operating profit. Although this means there is some concentration risk, the company believes these are attractive markets, especially Germany and the US which are more ‘affordable’ providing scope to increase price.

The second strand focuses on the broader tobacco portfolio where there are additional opportunities to drive growth whilst realising operational efficiencies. Finally, the group is building a targeted NGP business focused on heated tobacco in Europe and vaping in selective markets, particularly the US. Investment is disciplined and based on detailed market testing. Overall, rather than trying in vain to out-compete its larger rivals, we believe Imperial is now operating within the confines of what is achievable for a number four player in a concentrated global market.

The group’s five-year plan is divided into two distinct periods. The two-year strengthening phase (2020-2022) built the foundation for the current three-year phase (2022-2025) which focuses on the acceleration of returns and sustainable growth in shareholder value. In this phase, the company expects to generate low single-digit net revenue growth and mid-single digit adjusted operating profit growth, defined as 3.5%-6.5%.

During the latest financial year, adjusted net revenue (including Russia in the prior-year comparative) grew by 0.7% at constant currency to £8.0bn. Excluding the impact of the group’s exit from Russia, net revenue was up 1.4% at constant currency.

Tobacco revenue grew by 2.8% at constant currency. Strong pricing (+11%) was offset by a volume decline (-7.1%) and adverse mix (-3%). The group has generated a further modest gain – 10 basis points – in the aggregate share for its top-five markets over the full year. The US, Spain, and Australia enjoyed market share growth, more than offsetting declines in Germany and the UK. This has been achieved while delivering broad-based pricing gains across all five markets, reflecting recent targeted investments.

By region, Tobacco net revenue growth has remained strong in Europe (+2.8%) and the AAACE region (5.3%), more than offsetting declines in the US (-4.5%).

NGP revenue growth accelerated in the second half of the year, driven by strong growth in Europe (+40%), to leave the year up 26%. In all categories of next generation products – vape, heated tobacco, and oral nicotine – the group delivered a step-up in product and market launches during the year. The group is now present in more than 20 European markets, as well as the US.

Imperial delivered its annual savings target of £150m. Adjusted operating profit was up 3.8% on a constant currency basis to £3,887m, versus guidance for an acceleration to the lower end of the mid-single digit range. As expected, the rate of growth better than the 0.8% generated in the first half.

Tobacco adjusted operating margins increased by 180 basis points, driven by pricing more than offsetting cost inflation and investment. NGP adjusted losses increased by 48% to £135m, with higher investment in new product and market launches. These headwinds were mitigated by 17% growth in Distribution adjusted operating profit. Adjusted EPS increased by 4.2% to 278.8p, impacted by higher interest costs and a lower share count.

Regulatory issues remain an overhang – we note the proposed UK tobacco control measures – while a lack of market share improvement in Germany remains a concern.

The business typically generates strong cash flow which drives four pillars of capital allocation: investment in organic growth; strengthening the balance sheet; a progressive dividend; and share buybacks. During the year to 30 September, adjusted operating cash conversion was 92%. The group ended the year with net debt to £8.0bn, a touch below last year, and financial gearing of 1.9x net debt to EBITDA, versus its target of ‘around 2.0x’. The all-in cost of debt increased from 3.5% to 4.3% due to the refinancing of naturally maturing cheaper debt at higher rates and the impact of rising interest rates on the proportion of the debt that was not hedged. Interest cover stands at a comfortable 10.1x. The group remains committed to its investment grade credit rating.

In line with its capital allocation policy and reflecting management’s confidence in the group’s strategy and cash generation, Imperial is currently buying back £1.1bn of shares in a programme that will run until September 2024. This represents almost 7% of the group’s share capital based on yesterday’s market closing share price and comes on top of last year’s £1.0bn buyback. This commitment forms part of an ongoing, multi-year buyback programme that will deliver a material reduction in the capital base over time. The company believes this is preferable to buying back some of its expensive debt even though the cost of servicing that debt is rising.

The dividend policy is to grow the payout annually, considering underlying business performance. With today’s results, the group has declared a full-year dividend of 146.82p, 4.0% higher than last year, equating to a yield of 8%. The £1.3bn cost of the payout was almost 2x covered by the £2.4bn of free cash flow. Taking dividends and the buyback together, Imperial expects capital returns to shareholders will exceed £2.4bn in the coming fiscal year, representing around 15% of its current market capitalisation.

Looking ahead, the group expects the continuing benefits of its transformation to enable a further acceleration in adjusted operating profit growth in the final two years of its five-year strategy. In FY2024, the group expects to deliver low-single-digit constant currency revenue growth and to grow its constant currency adjusted operating profit close to the middle of its mid-single digit range. Performance will be weighted to the second half of the year, driven by the phasing of pricing in the prior year and investments in NGP. As a result, first-half operating profit is expected to grow at low single digits at constant currency.

Source: Bloomberg