Imperial Tobacco's (IMT) first-half results contained few surprises because the firm announced volume growth near the end of the period. Our investment thesis played out during the quarter, with Imperial outperforming in most of its core markets thanks to a value-focused product portfolio. We think the firm is well positioned to benefit from ongoing regulatory pressure in the UK, and our fair value estimate of £22 remains in place. Nevertheless, there could be more upside to the stock if Imperial becomes an acquisition target for one of the larger players.
Currency-neutral revenue grew 3% in the first half of fiscal 2011, despite a volume decline of 1%. This is in line with the 3% revenue growth in fiscal 2010, but we think some trade inventory shifts could mean that some purchases were shifted from the first half to the second this year, which could lead to revenue growth acceleration in the second half of the year. Most of Imperial's core markets remained weak, but the firm's positioning in discount brands and loose tobacco allowed it to gain share as smokers continued to be value-conscious. In the UK, for example, shipment declines of 2% were ahead of the 4% fall in industry volume. Spain continued to be very weak, with Imperial's shipment declining a staggering 16%, although this still beat the 18% industry decline. We expect Western European markets undergoing austerity measures and high unemployment to remain weak in the second half of the year, which should allow Imperial to continue to outperform the industry. In addition to its solid brand performance in developed markets, Imperial Tobacco is an emerging-markets play, with 60% of its volume derived in growing economies. Superpremium brand Davidoff continued to gain share as smokers in Eastern Europe, the Asia Pacific region, and Africa traded up. This is a trend that we expect to continue in the long term, economic cycles notwithstanding, and we think Imperial's product portfolio is well positioned to capture share as a result. Imperial's first-quarter operating margin increased 150 basis points to 18%, exactly in line with our expectations.
We think the market has finally recognised the value of Imperial's brand portfolio as trading down continues in developed markets and trading up resumes elsewhere. If these trends continue for some time, the company could come into play as an attractive acquisition target, with British American Tobacco (BATS), Philip Morris International (PM), and Japan Tobacco the likely suitors, and there could be more upside to the stock from current levels. As a stand-alone entity, however, the stock is currently fairly valued, in our view, although the dividend, which now yields more than 4% on an annualised basis, may still be attractive to income investors.
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