A Closer Look at Imperial Tobacco Group's Dividend Potential

LONDON -- Dividend income accounts for around two-thirds of total returns, the actual rate of return taking into account both capital and income appreciation. Given that share prices are often volatile and unpredictable, the potential for plump dividends can give shareholders much-needed peace of mind for decent returns.

I am currently looking at the dividend prospects of Imperial Tobacco Group  (LSE: IMT  ) (NASDAQOTH: ITYBY  ) and assessing whether the company is an appetizing pick for income investors.

How does Imperial Tobacco Group's dividend history stack up?

Metric 

2009

2010

2011

2012

FY Dividend per Share (pence)

73

84.3

95.1

105.6

DPS Growth

15.7%

15.5%

12.8%

11%

Dividend Cover

2.2 times

2.1 times

2 times

1.9 times

Source: Imperial Tobacco Group company accounts.

Imperial Tobacco has been a solid deliverer of double-digit dividend growth over the past four years, even though a slowdown in earnings growth has seen dividend expansion follow suit. Still, full-year dividend growth over the past three years has still comfortably outperformed earnings increases.

The firm's operations in a traditionally defensive sector -- historically speaking, global cigarette demand remains strong even in spite of broader economic weakness -- provides investors with extra security over future payments. And even though dividend cover has slipped in recent years, last year's reading was still around the benchmark reading of two times earnings, which generally represents very decent security.

What are Imperial Tobacco Group's dividends expected to do?

Metric 

2013

2014

FY Dividend per Share (pence)

116.1

128.1

DPS Growth

10%

10.3%

Dividend Cover

1.8 times

1.8 times

Dividend Yield

5%

5.5%

Source: Digital Look.

Imperial Tobacco announced in April's half-year report that tobacco net revenues fell 2% at constant exchange rates in September-March, to 3.3 billion pounds, which drove group adjusted operating profit 5.1% lower to 1.4 billion pounds. Weakness was attributed mainly to declining product demand in much of Europe.

More encouragingly, however, its key Gauloises Blondes, Davidoff, John Player Special, and West brands saw net revenues and volumes rise 5% and 1%, respectively, during the period, while group sales in the Asia-Pacific region, Africa, and the Middle East also took off. Imperial Tobacco's belief in future growth was affirmed by its decision to lift the interim dividend 11% and said that it plans to "grow dividends by at least 10% per year over the medium term."

City estimates expect moderate earnings growth during the year ending September 2013 and in the following 12 months to present healthy dividend expansion close to 10% during this period.

How does Imperial Tobacco Group's dividend prospects rate against the competition?

 

Prospective Dividend Yield

Prospective P/E Ratio

Tobacco

4.5%

13.6

FTSE 100

3.2%

15.7

Source: Digital Look.

Imperial Tobacco currently changes hands on a P/E rating of 11 for 2013, representing a chunky discount to its peers in both the tobacco and FTSE 100 sectors, while it also beats both groups in terms of projected dividends. I believe that the firm provides stellar value for money at current price levels given its plans to turbocharge future earnings.

Imperial Tobacco is embarking on an ambitious restructuring program, closing scores of local brands and refocusing operations toward its more successful main labels, which have far superior pricing power, and plans to create 300 million pounds of cost savings per annum from October to September 2018. In my opinion, this -- combined with rising turnover from developing regions -- should help to deliver increasingly exciting earnings, and consequently dividend, growth moving forward.

Furthermore, I believe that Imperial Tobacco's ongoing buyback policy sweetens the investment case for income seekers. Last year the tobacco specialists spent 528 million pounds on share repurchases and announced at 2012's finals that it plans to keep its buyback program rolling, with approximately 500 million pounds' worth of transactions targeted per year.

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