We like Imperial Tobacco plc (IMT LN) at GBP 34 levels because of its standalone valuation support added with a higher than previous probability that the likes of British American Tobacco plc (BATS LN) will move on Imperial. Near-term downside GBP 31-33. Near-term upside GBP 38-41.
Imperial Tobacco is the fifth largest, global tobacco company with a number 2 position in Europe and number 3 in the US. On 20 November 2015, FT Alphaville reported that “advisers to BAT” have put together a group of banks to finance a possible deal – although article stated that “No approach has been made, with no certainty one ever will be, people claiming direct knowledge of the process have told FT Alphaville. All that’s happened so far is that advisers to BAT have corralled together a syndicate of investment banks willing to support an offer”. FT article follows Imperial’s CEO, being quoted in an earlier November Telegraph article saying: “It’s not impossible but it’s not an easy scenario to see playing out . . .These rumours come and go, I’ve been in this job now for over five years and sometimes the speculation seems to pick up and sometimes it dies down again.”
Although these takeout rumours for Imperial have existed as long as SABMiller’s take out rumours (…), we believe that a deal for Imperial is real and makes strategic / financial sense as the global tobacco market (top 5 players currently control 83% of the global cigarette market: China National Tobacco Corporation, Philip Morris International, British American Tobacco, Japan Tobacco International and Imperial Tobacco) might follow the US market with only 3 players in most, international markets: with the FTC having just a couple of months ago allowed the US industry to move from 4 main players to 3 (after approving tie up between Reynolds and Lorillard), an acquisition of 4th largest player (Imperial) by either one or more parties looks just matter of time.
Although we appreciate the news flow is still very much rumour based (fact that no statement was issued last week by Imperial, indicates that no talks are currently taking place, otherwise UK Takeover Panel would most likely have pushed parties to come out with a (PUSU) statement), we like Imperial because of its valuation support (and limited earnings risk) and hence do not believe current levels reflect too great of an M&A /speculation premium given:
1) P/E multiples: Applying pre-rumour average 14.5x NTM P/E (historic range between 10x and 16x) on Imperial’s 2016 consensus EPS of GBP 2.37 implies price of GBP 34.37 (vs BATS and Philip Morris trading at 17.5x and 19x NTM P/E), with upside risk to earnings given EPS accretion/synergies on the large scale US cigarette assets that Imperial acquired earlier in 2015 for $7.1bn (as part of the divestiture package announced with the tie up between the 2nd and 3rd largest US cigarette companiesReynolds and Lorillard)
2) Dividend yield: Applying 4% dividend yield on Imperial’s 2015 Dividend of GBp 141 implies price of GBP 35.25 (while company has stated it will grow its DPS by 10% a year).
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