Is FTSE 100 Stalwart Imperial Tobacco Group Good Value?   

LONDON -- Capital appreciation is surely the goal of many investors. One method of achieving that is to buy companies with steady earnings growth. If bought when the shares are cheap, two drivers could move the share price up:

• growth in earnings, and
• an upwards P/E re-rating.

Highly successful fund manager Peter Lynch classified steady growers as Stalwarts, which he typically traded for 20% to 50% share-price gains. But whether buying for gains like that or holding for the longer term, we need to know if reliable earnings growth can continue, and whether the shares are cheap.

Seeking durable growth
Not all companies achieve stable growth as you can see by the aggregate performance of those in London's premier FTSE 100 index (INDEX: ^FTSE), where the compound annual earnings-growth rate has been just 0.7% over the last five years:

Consistent, cash flow-backed growth in profits is a promising characteristic in today's markets so, for this series, I'm examining firms with annual earnings growth between 4% and 20%.

One contender is Imperial Tobacco Group (LSE: IMT.L), which is a tobacco products manufacturer and distributor. This table summarizes the company's recent financial record:

So, earnings have grown at an equivalent 12.2% compound annual growth rate, putting Imperial Tobacco in the Stalwart category.

Imperial Tobacco gets its products into more than 160 countries worldwide. Its "Rest of the World" category delivers the biggest revenue at 33% followed by its "Rest of Europe" category at 23%. After that, 13% of revenue comes from the U.K., 13% from Germany, 11% from the Americas, and 7% from Spain.

Earnings growth seems set to continue, driven by the addictive nature of the firm's product. Its cash-generative business, reflected in the healthy looking dividend. If Imperial can keep converting demand into cash, as it has been, the prospects of continued earnings growth seem promising.

Imperial Tobacco's earnings growth and value score
I analyze five indicators to determine whether earnings growth can continue and if the shares offer good value:

1. Growth: revenue and earnings have been growing with cash flow supporting profits. 3/5
2. Level of debt: net gearing around 138% with borrowings about five times earnings. 2/5
3. Outlook and current trading: good recent trading and a cautiously positive outlook. 4/5
4. Enterprise value to free cash flow: historically around 15 and above growth rates. 2/5
5. Price to earnings: historically around 12 and similar to average earnings growth. 4/5

Overall, I score Imperial Tobacco 15 out of 25, which encourages me to believe this stalwart can continue earnings growth that out-paces that of the wider FTSE 100. However, compared to the FTSE's price to earnings ratio of around 11 and the firm's growth predictions, the shares seem to value the company fully.

Foolish summary
Imperial carries a big chunk of debt, but the steady cash flow seems to make it easy for the company to stay on top of interest payments. The enterprise value to free cash flow ratio reveals a richer valuation than might otherwise be evident at first glance.

Right now, forecast earnings growth is 7% for 2013, and the forward P/E ratio is around 11 with the shares at 2317 pence. Considering that and the other factors analyzed in this article, I think that Imperial can stay on my watchlist for now, although its forward dividend yield looks attractive for income investors.

Imperial Tobacco Group is one of several steady-earnings-growing stalwarts on the London stock exchange, each with the potential to deliver significant capital appreciation when purchased at sensible prices.

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