Does your mother know

Ask 10 people what ethical means and you’ll probably get 10 different answers, and kick off a heated discussion about the topic. It can be a rather emotive subject for investors too. Some would be quite happy to include oil and mining stocks in an ethical portfolio, yet others would cite their negative environmental impact and say they were therefore unethical.

So finally I decided to narrow the scope to so-called ‘sin stocks’. It’s generally accepted that ‘sin stocks’ are those belonging to sectors that include alcohol, tobacco, gambling, weapons manufacture, and other naughty things you wouldn’t want your mother to know about.

Defensives

It’s not as easy as it seems, when you consider that companies in these sectors have generally outperformed the market over the years, with many now even considered as ‘defensives’. In other words, even when the economy is struggling, people are less likely to cut back on booze and tobacco for instance, than they are on retail and housing.

What does it say about society when alcohol, tobacco, and gambling rank alongside gas, water, electricity, toothpaste, and toilet paper as everyday essentials? When times are good – people drink, smoke and gamble. When times aren’t so good, they do so even more.

A healthier alternative

Core holdings like Diageo, Imperial Brands and British American Tobacco might not be that well known to those outside the investment community. But with instantly-recognisable global brands such Guinness, Baileys, Rothmans and Lucky Strike in their portfolios, these three goliaths last year managed to amass sales in excess of £60bn, with a large chunk of the profits being distributed to their shareholders.

Is there an alternative? I think there is. Why not invest in equally defensive companies that produce inhalers, vaccines, and cancer treatments? I’m talking about London-listed pharmaceutical giants GlaxoSmithKline and AstraZeneca. Both are go-to stocks in times of economic uncertainty, and both pay healthy dividends to their loyal shareholders. You’ll probably feel better about it too.

The only way is ethics

As one of the world’s largest weapons suppliers, BAE Systems has long been a target for both campaigners and investors, with the multinational defence contractor last year pulling in almost £19bn of business from countries all around the world.

Medical technology business Smith & Nephew on the other hand has been helping the wounded since the outbreak of the First World War. The company’s advanced wound management and joint replacement systems have helped to deliver an enviable track record of revenue and earnings growth over the years, and I see the company as a worthy alternative to BAE in a ‘sinless’ portfolio.

And as more corporations realise their customers expect them to ‘do good’ (as well as making good products) they’re more likely to take an actively ethical approach to business, making it even easier to avoid sin stocks.

As you can see, it’s just as easy to build a winning portfolio with companies you’d be proud to own, as it is with more ethically-challenged stocks. So why not give it a try?

The post How to make a million WITHOUT buying ‘sin stocks’ appeared first on The Twelfth Magpie.

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Bilaal Mohamed has no position in any shares mentioned. The Motley Fool UK owns shares of and has recommended GlaxoSmithKline. The Motley Fool UK has recommended AstraZeneca, Diageo, and Imperial Brands. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

Wringing the rag dry

Today isn’t the first time that I have written about this subject. In my view, investors in companies like Imperial Tobacco should probably be slightly concerned about leverage, particularly in light of the cost implications that rising interest rates will have.

Both businesses are highly leveraged while operating within a challenging regulatory and consumer environment. In my view, the long-term investment case for these companies is diminishing, and in light of the recent gains, investors should reassess their positions in the shares.

With organic revenue growth topping out long before now, management at both companies have only two options available to meet their commitments to shareholders. These are: a) boosting earnings and returns by cutting fat from the bone (cost cuts); or b) inorganic growth through acquisition.

Now both companies have made progress in their efforts to reduce product costs and to reduce operational costs in recent periods, but this strategy can only ever yield limited gains without further acquisitions.

This is while I cannot help but feel that M&A driven growth is merely a move to delay the inevitable. This is because any acquisitions will probably involve the issuance of at least some debt in addition to taking on the debts of the acquired company, which merely reinforces my concerns over leverage.

If the tobacco industry were a leather rag then I would be inclined to describe it as one that has almost been wrung dry, at least as far as investment potential is concerned…

Leverage, either which way…

In the year to September, total debt at Imperial increased by a considerable 43%, bringing debt/equity to 2.7x, which means that the group now has nearly three times the amount of debt as its shareholders do equity.

For those who thought that it would be difficult to top that, BAT is actually worse off than its rival Imperial, with total borrowings up by 26% year to date and debt/equity now over 3.1x.

Furthermore, if BAT were to acquire Imperial, the combined entity’s balance sheet would be little improved without a considerable rights issue.

Valuation, dividends & disappointment

From a valuation perspective, the shares now trade at 15x the consensus estimate for earnings in the current year, which compares well with the 18.5x multiple for BAT. However, it is an open question as to whether these multiples could be judged as appealing or not.

In addition, despite Imperial honouring its pledge to grow dividends by 10% per annum in the year to September 2015, broker estimates suggest that shareholders could now be in for a disappointment in the current year.

The average estimate is for dividend growth in the low single digits — with implied cover at 1.5x, for the current period.

Summing up

To me, the leverage issues mean that any anticipated cost synergies would have to be significant for the rumoured deal to offer any tangible benefit to shareholders.

Just about the only thing that is clear at present is that Imperial shares have benefited considerably from various forms of speculation of late, while high leverage and the prospect of meagre dividend growth ahead continues to do the underlying investment case little justice.

Therefore, either which way, it would seem most likely that any further gains are going to be limited from here.

As a result, I’d probably take the quarter’s performance as a cue to book profits and walk away before anybody else does — and certainly before interest rates begin to move.  

The post Why I Wouldn’t Buy Imperial Tobacco Group Plc Or British American Tobacco plc appeared first on The Twelfth Magpie.

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James Skinner has no position in any shares mentioned. 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.

I have held Imperial Tobacco for years, as I initially wanted the stable dividend that tobacco stocks offer. However, the company has outperformed hugely and has made a fantastic return. In the current environment, cigarette companies need to be relatively creative to keep profits up. Cigarette volume is declining around the sector but Imperial Tobacco has managed to keep profits up and increase the dividend, which has placed the shares in demand. Large cigarette companies like Imperial Tobacco are lucky to have very little competition and that a few big companies own most of the brands around the world. 

This good run looks set to continue. The company recently acquired brands from the Reynolds American takeover of Lorillard. This increases Imperial’s market share of the huge US market to 10% from the previous 3%. A key brand in this deal is the new e cigarette brand called Blu. This looks to be a highly valuable growth brand that should grow Imperial’s earnings in the future. 

The company has recently been involved in takeover rumours with a possible acquirer coming from Asia. Japan Tobacco has been mentioned as a potential acquirer, with the help of British American Tobacco. This would not surprise many analysts who say Imperial has always been a takeover target. These rumours don’t mean Imperial is a slam-dunk buy, however, and takeover rumours must always be taken with a pinch of salt. They have, though, added fuel to the share price — but I still believe the price will push on up even if there is no takeover. 

The dividend yield is at 4.1% and the dividend cover is 1.25. The P/E ratio is also only around 15, which is less than its main rivals including BATS. The dividend is also set to increase in the next few years and 2015 earnings grew by over 18%. These earnings are set to increase further as the new US brands boost earnings higher.   

The bullish view on Imperial is also shared by Britain’s most loved fund manager, Neil Woodford. His CF Woodford Equity Income Fund has increased its holding of Imperial, and it now accounts for 7.8% of his entire fund. 

Overall, Imperial offers good returns in the next few years as its new brands begin to grow further. The yield of around 4% is very healthy and should increase in the next few years. If the company is taken over then so be it, but City analysts still see it as unlikely. The shares still remain a good potential investment, especially for income-seeking investors, over the long term. 

The post Does Imperial Tobacco Group PLC Still Offer Returns After A 25% Rise This Year? appeared first on The Twelfth Magpie.

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Jack Dingwall has shares in Imperial 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.

It is the addictive nature of smoking that provides tobacco companies with resilience throughout the economic cycle, thereby affording them the cherished, defensive status within London’s community of listed companies.

It is this status, along with a strong performance within the underlying businesses, that has consistently propelled Imperial Tobacco (LSE: IMT) and British American Tobacco (LSE: BATS) to new highs during recent years.

However, today I write to urge caution to those investors that are hoping for continued gains from these shares — as it could be that this period of outperformance is about to come to a halt for both companies.

Below I explain why.

Balance sheet leverage could soon become an issue  

An extended period of ultra low interest rates, in addition to sustained earnings and dividend growth, has enabled the expanding balance sheets of Imperial Tobacco and British American Tobacco to go largely unchecked.

Now, with an increase in both US and UK interest rates just around the corner, both companies may soon need to think about deleveraging.

At present, debt/equity sits at 1.93x and 2.48x for BAT and Imperial Tobacco respectively, while gearing comes in at 69% and 59% respectively.

Even for defensive companies, these numbers are slightly disconcerting, particularly when considering that annual earnings growth is often confined to the low-mid single digits for tobacco firms.

Dividend cover is also a potential cause for concern

In addition to slightly overweight balance sheets, an extended period of generous dividend growth has now begun to reduce the level of dividend cover offered by BAT and Imperial Tobacco to uncomfortably low levels.

Dividend cover at British American Tobacco is the lowest of the two companies, coming in at just 1.2x DPS, while consensus projections for earnings suggest that EPS growth will remain in the single digits out until at least 2017.

However, in its defence, the group has made no prior commitment to a set rate of dividend growth here. Instead, management have repeatedly stated the while increasing the payout is a priority, this will only happen as and when its is possible to do so.

Dividend cover is much more pertinent issue for Imperial Tobacco, who have pledged to grow the payout by 10% per annum over the medium term, even though cover was just 1.15x in 2014.

Furthermore, consensus earnings projections for Imperial Tobacco indicate that it will fare little better than BAT when it comes to EPS growth over the coming years, as the annual pace of expansion here is also expected to remain in the mid single digits until 2017.

This places a considerable question mark over the viability of further dividend increases over the medium term and I now believe it is possible that shareholders may find themselves being left disappointed at some time between now and the end of the above forecast horizon.

Summing Up 

In summary, while it may certainly be possible for both companies to maintain the current per share distribution over the next 24 months, further growth is looking increasingly unlikely over the near term.

This will make it difficult for the shares to record further gains from here and, as such, it probably means that the lengthy period of outperformance that both companies have enjoyed is now coming to an end.

The post Are Imperial Tobacco Group Plc & British American Tobacco Plc Running Out Of Puff? appeared first on The Twelfth Magpie.

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James Skinner has no position in any shares mentioned. 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.

Tobacco revenue for the period declined 4% as foreign currency movements weighed on sales. However, on a constant currency basis, a calculation that neutralises the effect of negative exchange rate movements, Imperial’s revenue increased by 2% for the nine months to 30 June. Over the past six months, Imperial’s tobacco sales increased 3% on a constant currency basis.

Still, Tobacco volumes for the reported period declined 3%. However, Imperial’s growth brands reported a 15% increase in volume sold during the period. 

Impressive figures

Imperial’s figures for the first nine months of the year highlight the company’s strengths. Indeed, the company is growing in all key areas. Its market share expanded 1% during the period, the sales of growth and specialist brands are rising, the group’s operating profit margin is increasing and cash conversion (the percentage of net profit converted into cash) is expected to be 90% for full-year 2015. 

What’s more, Imperial is committed to rewarding its shareholders. Management is planning a 10% dividend hike this year, which will be Imperial’s sixth consecutive 10% annual dividend hike. During the past five years, Imperial’s dividend payout has increased by 70%.

Surpassing peers 

British American Tobacco (LSE: BATS) and Diageo (LSE: DGE) could be described as Imperial’s closest peers. Together, British American and Imperial make up the whole of the FTSE 100’s tobacco sector while Diageo’s similarities lie in the nature of its product offering. 

Specifically, Diageo can be described as being a ‘vice’ stock, due to its connection with alcohol. Tobacco companies such as British American and Imperial are also known as vice stocks.

So, how do these vice companies compare? Well, on the face of it Imperial has produced the best returns for shareholders over the past five years. The company’s shares have produced a total return (including dividends) of 15.4% per annum since 2010. British American’s shares have returned 14.4% per annum, and Diageo has produced a total return of 13.2% per annum for investors. 

But even after putting in an impressive performance during the past five years, Imperial still looks to be undervalued compared to its two vice sector peers. 

For example, at present Imperial currently trades at a forward P/E of 15.7 and supports a dividend yield of 4.3%. The company’s earnings per share are expected to expand 2% this year and a further 12% during 2016. Analysts are forecasting yet another 10% dividend hike next year. 

On the other hand, British American and Diageo currently trade at forward P/Es of 17.8 and 19.7 respectively. British American’s earnings are not expected to expand this year. City analysts expect Diageo’s earnings to tick higher by 3% during 2016. Diageo and British American’s shares currently offer dividend yields of 3.3% and 4.2% respectively. 

The bottom line

So overall, based on Imperial’s valuation, the company’s steady earnings growth, and dividend expansion, the company looks to be the best of the vice stocks. 

The post After Today’s Trading Update, Is Imperial Tobacco Group PLC A Better Buy Than British American Tobacco plc Or Diageo plc? appeared first on The Twelfth Magpie.

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Rupert Hargreaves owns shares of Imperial Tobacco Group. 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.