Imperial Tobacco’s (IMT) 2013 results slightly outperformed our estimates as adjusted earnings per share grew 5% to 210.7p, compared to our 207p estimate. As a result, we will likely be slightly increasing our £23 fair value estimate on the company’s shares as we adjust our model for the time value of money.
We continue to believe that Imperial’s wide moat (competitive advantage) is fortified by its strong brands, global reach, and the addictive nature of tobacco. In an effort to more keenly focus its business efforts, Imperial is adjusting its segment reporting structure from geographically based to strategic role-based. Growth Markets such as Russia, Japan, Turkey, and the U.S. which have large profit pools and small Imperial market shares; and Returns Markets North; including the U.K., Poland, and Germany, and South; including France, Portugal, and Spain, which are characterized by more meaningful Imperial market shares.
Imperial also strengthened its non-tobacco ventures by forming Fontem Ventures, which will focus on launching new products during 2014. Given the company’s recent purchase of Dragonite’s eCig intellectual property, we are confident that Imperial will be launching an eCig in the EU. We caution investors that while eCigs currently provide ample growth opportunities, the market is much more crowded than the cigarette market. Just about every major tobacco company has launched or will launch an eCig brand in the coming year, and there are hoards of independent eCig sellers racing to get a piece of the pie. As such, we are concerned that the profit potential of eCigs may not be up to snuff compared to traditional cigarettes.
Longer term, we still expect that Imperial’s top line will grow 2% to 3% per year as price increases more than make up for volume declines. Additionally, we expect that during the next five years the company’s operating margins will hover around 40%, similar to where they have been over the past few years.
