However, with mixed results released today by Imperial Tobacco (which includes a 10% increase in its dividend), is it a better buy than British American Tobacco? Or, should you stick with latter, and larger, of the two companies?
Todays full-year results from Imperial Tobacco show that the company is making encouraging progress during a transitional period for tobacco companies.
Of course, on the face of it, the results are somewhat disappointing. Thats because the company has reported a year-on-year fall in revenue of 6% and a drop in earnings per share (EPS) of 3%. However, delving a little deeper shows that two factors have caused Imperial Tobaccos top and bottom lines to disappoint. They are currency headwinds and a stock optimisation programme, which involves Imperial Tobacco reducing the level of stock held by distributors in order to improve long term efficiency.
Removing these two factors means that revenue increased by 2% year-on-year, while EPS increased by 7%. This has allowed the company to increase full-year dividends by 10%, with a dividend coverage ratio of 1.6 times showing that headroom remains very comfortable. Furthermore, Imperial Tobacco is forecast to increase dividends by another 9.5% next year, which is eight times the current rate of inflation.
Crucially, the stock optimisation programme is now complete and has left Imperial Tobacco in a stronger position, being able to deliver 60 million of cost savings in the current year. Furthermore, the company remains on track to meet its target of delivering annual savings of 300 million from September 2018. This would clearly make a hugely positive impact on margins and help the company to combat the industry-wide declines in cigarette volumes, with Imperial Tobacco seeing its volumes fall by 7% this year.
Of course, a major reason for declining volumes is the introduction of e-cigarettes to the market place. To an extent, this new growth space should help tobacco companies like Imperial Tobacco and British American Tobacco to overcome regulatory risks and a more health conscious consumer, with e-cigarettes apparently being less harmful than tobacco products.
In this area, both Imperial Tobacco and British American Tobacco have huge growth potential. In Imperial Tobaccos case, it has purchased the market leading US e-cigarette brand, blu, and also has a UK-focused brand called Puritane. Meanwhile, British American Tobacco has had its own Vype brand at market for well over a year and is making encouraging progress with sales.
While volume declines are a concern for all tobacco companies, the introduction of e-cigarettes could provide them with a stunning growth opportunity. Indeed, when combined with substantial cost savings and the potential for further pricing strength in tobacco, profits are likely to continue to move higher in the high single digit range over the medium term for both Imperial Tobacco and British American Tobacco.
Indeed, while both companies remain hugely appealing at their current price levels, Imperial Tobacco seems to offer better value and a more enticing yield than its rival. For example, it currently has a price to earnings (P/E) ratio of just 13 (versus 17 for British American Tobacco), while its yield of 4.6% is also more attractive than that of its sector peers 4.1%. As a result, Imperial Tobacco could prove to be the better buy out of what are two highly appealing stocks.
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Peter Stephens owns shares of Imperial Tobacco Group and British American Tobacco. The Motley Fool UK has no position in any of the shares mentioned. We Fools don’t all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.