Shares in Imperial Brands (IMB) have lit up the market year-to-date, rising 25% to trade at a multi-year high of £20.19 with outperformance of the FTSE 100 reflecting the cigarettes-to-vaping company’s prized defensive qualities during uncertain times for equity markets and the global economy alike.

Yet based on investment bank Bank of America’s forecasts for the year to September 2024, Imperial Brands trades on just 6.7 times earnings and offers a dividend yield of 9%, metrics which scream there’s cracking value on offer here.

Smoking and vaping are addictive, giving the globe’s fourth largest tobacco player formidable pricing power, but they are also very unhealthy habits, which means the shares possibly won’t appeal to investors who place heavy emphasis on ethical considerations.

Nevertheless, the Bristol-headquartered consumer products firm is a compelling investment solely from a total returns perspective. Imperial Brands is generating so much surplus cash that it is going to return more than £2.3 billion of it to shareholders through dividends and share buybacks in the year to September 2023.

That’s equal to over 12% of the current market capitalisation, whilst continuing to invest in the business to ensure it remains competitive in the future. A key catalyst for further upside as investors are drawn in and the lesser share count enhances earnings per share, the buyback also demonstrates that despite this year’s gains, management led by highly regarded CEO Stefan Bomhard still believes the shares represent great value.

LIGHTING UP THE MARKET

For the uninitiated, Imperial Brands produces and markets cigarettes, cigars and rolling paper with brands including Davidoff, Gauloises, West, Winston, John Player Special and Lambert & Butler in cigarettes, as well as Rizla rolling papers and Backwoods cigars, not to mention an exciting portfolio of next-generation products (NGP) such as the Pulze device and iD sticks, which make up its heated tobacco offering, and the vape brand blu.

The £18.9 billion cap’s products are bought in high volumes on a regular basis by millions of people around the world, creating steady cash flows, while demand for cigarettes tends to be inelastic - demand doesn’t change in response to rising prices. Combined with consolidated structure of the tobacco industry, this confers pricing power on the business.

Imperial Brands’ shares puffed higher following a reassuring trading update (6 October) covering the year to September 2022 which confirmed the tobacco titan is on the right track to improve its underlying business. In line with previous guidance, Imperial Brands said it expects full year net revenue and adjusted operating profit to both grow by around 1% at constant currency.

Guided by Bomhard, Imperial Brands reported improved market share in its top five combustibles markets (US, UK, Germany, Spain, Australia), which speak for about 70% of the group’s operating profit. And at constant currency, the growth rate of Imperial’s tobacco sales actually improved in the second half compared with the first, driven by a stronger price mix.

In the NGP business, the future growth engine which includes vapes, heated tobacco and oral tobacco, Imperial Brands flagged encouraging market share gains in the Heat Not Burn category in Greece and the Czech Republic as well as a launch in Italy, Europe’s largest heated tobacco market. The company also highlighted positive results from a consumer trial of blu 2.0, a new pod-based vapour device, in France.

WHY IMPERIAL BRANDS CAN PAY OUT SO MUCH CASH

But the big news from the statement was the start of an ‘ongoing, multi-year’ share buyback programme, starting immediately with a bumper £1 billion buyback over the next 12 months to September 2023. This lavish return of capital, on top of the ordinary dividend, is being made possible thanks to the group’s strengthened balance sheet and a leverage ratio that is now at the lower end of management’s two to two and a half times net debt to EBITDA target.

Bomhard insisted the new buyback is ‘underpinned by this improving performance and our confidence in being able to continue generating strong cash flows to support growing shareholder returns in the years to come. We are committed to a progressive dividend and an ongoing buyback programme to meaningfully reduce the capital base over time’, he enthused.

Modelling an earnings per share-enhancing £3 billion share buyback over the next three years, Bank of America believes the company can ‘unlock significant value by pulling the right levers by refocusing its tobacco business, stepping up support behind Heat Not Burn and delivering efficient capital allocation’.