Analyst Note| Philip Gorham, CFA, FRM |
After digesting Imperial Brands' new five-year strategic plan, we are tweaking our assumptions and lowering our fair value estimate to GBX 3,000 from GBX 3,400. Our lower valuation reflects what we think are realistic assumptions based on Imperial's position in the marketplace: a highly cash generative business, but a company not in a position to drive industry growth. It does not imply a material change in view, and we still regard Imperial as being grossly undervalued. The stock trades at less than 9 times forward earnings and offers a dividend yield of 10%, even when last year's dividend cut is annualized. The tobacco industry faces a structural decline in its core business, and it is fair to say that Imperial Brands will not be at the forefront of the shift to next generation products. However, with tobacco operating margins north of 40% and very high cash flow conversion rates of close to 100%, we expect the business to continue to generate a great deal of cash, and this is not being fairly reflected in the current market valuation. In fact, for the first time in a few years, Imperial has a realistic roadmap to better financial performance, that if delivered, has the potential to support a rerating of the stock to earnings multiples closer to historical averages in the midteens range.