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We Think the Market is Undervaluing Imperial

Imperial has a strong presence in some growth non-cigarette categories, and in an industry that is overall slightly overvalued, we like Imperial’s positioning for future cash generation

Philip Gorham, CFA 31 March, 2011 | 10:10AM

Morningstar equity analysts have this week been attending the Consumer Analyst Group of Europe conference in London, highlights from which included updates from Imperial Tobacco and SABMiller.

Imperial Tobacco (IMT)
CEO Alison Cooper’s focus was on the total tobacco space at the CAGE conference. Imperial has a strong presence in some growth non-cigarette categories, and in an industry that is overall slightly overvalued, we like Imperial’s positioning for future cash generation, and we think the market is undervaluing the firm. Around 40% of Imperial’s revenue is generated in developed markets, where volumes are slowing and trading down is ongoing amid a weak consumer environment. With a portfolio skewed to economy brands, we think Imperial is well-positioned to benefit from continued trading down. In developing economies (60% of revenue) there has been a long-term trend of trading up, which slowed materially during the recession, and even reversed in some markets, but there are signs in some markets in Asia and Eastern Europe that uptrading is slowly returning. Imperial is also well-placed to benefit when it does recover. Cooper spent significant time at CAGE discussing super-premium brands such as Davidoff cigarettes, which has a 6% 5-year volume CAGR, and Monticristo cigars. We think that if mid-single digit growth rates from three years ago are resumed, Imperial should achieve solid growth in emerging markets, and this could provide a catalyst for multiple expansion.

Another growth opportunity lies in smokeless tobacco in the U.S. We expect Imperial to test market its skruf and Knox smokeless brands in the U.S. sooner rather than later, because smokeless represents a gap in its product portfolio in that market. Recent evidence from Altria’s price cuts on Copenhagen, which demonstrated the price sensitivity of consumers, suggests that market share in smokeless is up for grabs, and we expect Imperial to grow its position in the category over the medium term.

We think there is around 15% upside to Imperial’s shares, which are trading at under ten times fiscal 2012 earnings. Although we recommend waiting for a slightly larger margin of safety, given the exposure to the oil price from the recently-acquired logistics business of Altadis, and we think Philip Morris International is the best-in-class international tobacco player, Imperial is our current pick in an industry that currently offers few opportunities for value investors.

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Securities Mentioned in Article
Security NamePriceChange (%)Morningstar
Rating
Imperial Tobacco Group PLC2,511.00 GBX0.64
About Author

Philip Gorham, CFA  Philip Gorham, CFA, is an associate director of equity research for Morningstar.