Tobacco + Life Insurance - the perfect hedge?

Health Warnings may be counter productive click image to read more!

It just so happens that we have had announcements by stocks in these two sectors today. When you think about it they are quite good partners in a portfolio as one is exposed to longevity risk in its business while the other sells products that help to reduce life expectancy, despite what the picture above might suggest. Indeed back in the days of conglomerates BATS even owned a life company (Allied Dunbar / Eagle Star) and Imperial was part of the infamous Hanson Trust before it was broken up and Imperial was de-merged. 

Imperial Tobacco (IMT) announced their interim results to 31st March 2014 in which they saw revenues down by 5%, operating profits by 4%, earnings by 1% but the dividend was increased again by 10% which is around the rate of growth forecast for the full year. Aside from the headlines numbers being down they point to Specialist & growth brands / markets being up. While they also suggested significant stock reductions were achieved, which impacted volume, revenue and profit - begs the question if they had stuffed channels in the previous years to hit numbers? They also said they are on track to deliver £60 million of cost savings from their cost optimisation programme this year and a total of £300 million by 2018.

Looking ahead they said they will move to paying quarterly dividends from 2015 and expect modest adjusted earnings per share growth at constant currency and further dividend growth of at least 10%. They talk about their actions providing a stronger platform for generating quality sustainable growth. They say that trading conditions are unlikely to materially improve in the coming months but that they are experienced in growing their business in a demanding environment and remain on track to achieve their targets and create further value for shareholders. 

They also emphasise that their cost and stock optimisation programmes supports their growth ambitions. On this it looks to me like cost cutting and share buy backs are probably supplying up to half of the likely 5%(?) or so underlying growth, which I guess is not surprising for a mature business such as this. It does beg the question how they can sustain dividend growth at 10% per annum in the medium term, especially as the dividend is only covered 1.6x or so by earnings and cash flow. The other concern with this one for me is the balance sheet as I have noticed it coming out badly on Z-Score screening (risk of bankruptcy). This reflects the £9 billion or so of debt versus the £24 billion or so market capitalization and I note that the interest cover is forecast at less than 3 times (2.85), a level which I use a threshold for identifying financial risk.

So in summary - a bit of a curates egg this one - OK value around 12x earnings with a good yield and growth of 5% & 10%, but lowish cover and a geared balance sheet. However it is a pretty stable / declining business with strong cash flows and I guess it does have some assets like Logista in Spain that it is looking to IPO which would reduce the debt burden. I guess it will depend how much they can get for it versus the £73 million operating profit as to whether it goes and helps the finances or not. Thus on balance I'm inclined to run with it but it looks to have got over bought recently and is towards the top of it range over the last three years so I wouldn't be adding to it or chasing it up here. It should probably outperform if the market sags back from here but will likely lag a renewed rise in the market, but Ok as part of a diversified income portfolio.

I'll also be watching developments in the e-cigarette market and how they cope with this. It seems they have started to respond to this with acquisitions and their own products, but this could easily be a threat rather than an opportunity - lets hope they don't go the way of EMI and HMV after they failed to adapt to new technology.

Meanwhile in the Life sector we have had a Q1 IMS from Legal & General (LGEN) today which I wrote up recently after it got hit by the announcement on annuities in the budget. So I'll not dwell too much on the operations here but note that they highlighted lots of strong growth across board and posted record results. They also highlighted that "they benefit from favourable demographic trends; we have economically and socially useful products for customers; and with our LGIM economists forecasting 3% plus economic growth in the UK and US, we are excited about the prospects for our business."


So in contrast to Imperial they offer socially useful products! The shares are up now by around 5.7% since I last wrote about them at the end of March and they have now gone ex the final dividend which is worth 3.3%. This is another 5% or so yield stock with double digits growth forecast and around 1.5x cover in a fairly mature industry. However, it looks to me that the growth prospects and cash flow here should be more robust although uncertainty about the longer term impact of the annuity changes remains. On that basis I'm happy to hold this one as a well managed play on demographics and funding a decent retirement for people and me!