Playing UK Consumer Growth with Imperial Tobacco

| About: Imperial Brands (IMBBY)

The UK population has topped 60 million for the first time and it is growing at its fastest rate in 40 years, according to government statistics. News of this burgeoning populace led us to focus on consumer-oriented companies based in the UK. Looking for such companies that are also growing earnings at an industry-leading pace turned up Imperial Tobacco Group Plc (ITY), which also has grown its dividend sufficiently to land on the Reuters Select stock screen for Income Stocks.

A larger population obviously means more consumers to buy products. But, if the population is growing because of a baby boom, then consumers would buy products that are different from what they would purchase if the growth came from immigration of adults.

According to the government, there has been an increase in the number of births, accompanied by a decrease in the number of deaths and record longevity. But, the bulk of the population surge arose from immigrants arriving from Eastern European countries. According to Guardian Unlimited, 82 percent of these immigrants are between 18 and 34 years old, with no dependents.

With that in mind, we looked for companies that might benefit from this influx of workers and consumers. We started off by concentrating on all UK-domiciled companies with American Depositary Receipts (ADRs) that recently appeared on at least one Reuters Select stock screen. This resulted in a list of a dozen names. Click here to download an Excel spreadsheet comparing these 12 companies.

We then focused on companies in the consumer sectors, both cyclicals and non-cyclicals, along with companies in the retail and investment services industries. This narrowed down our list to five members.

We want companies that are improving earnings and where management has effectively used capital to generate net income. For this, we stressed companies with fast earnings per share [EPS] growth and relatively high return on investment [ROI] figures compared with the respective industry norms. This helped Imperial Tobacco pull ahead. Its ROI in the trailing 12-month [TTM] period is 16.8 versus an industry average of 15.8. Also, it has been posting EPS growth rates that are both superior to the industry averages and accelerating over time, as the TTM figure is faster than the five-year pace, and the clip in the most recent quarter [MRQ] is quicker yet.

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On Aug. 3, the Bank of England unexpectedly raised interest rates for the first time in two years in an effort to ease inflationary pressures. This led us to focus on companies that are trading at reasonable valuations, on the basis of price to earnings [P/E] and P/Sales ratios relative to the industry averages. The thought here is that stocks with lower price tags don't have as far to fall as those with lofty valuations if market conditions turn sour or the central bank decides on another rate hike.

Imperial Tobacco is priced at a slight premium to the industry norm on the basis of P/E, but its P/Sales ratio values the ADRs at a discount.

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Although these factors helped us zero in on Imperial Tobacco, it is the company's dividend that enabled it to land on a screen for our consideration in the first place. The company has grown its dividend at an average annual clip of 16.2 percent over the last five years - about double the industry's pace. Thus, Imperial Tobacco easily satisfies a core requirement of the Income Stocks screen: A company's dividend growth rate must be greater than zero and must stand at least 10 percent above the industry average.

When looking for dividends, a key consideration is the payout ratio - that portion of net income that is doled out to shareholders in the form of dividends. We want the payout ratio to be high, but we don't want it to be too high. An exceptionally high ratio could mean that management is not reinvesting enough of the profits back into the company to help it grow. To make sure that we have not identified such a firm, the screen requires that the TTM payout ratio must be no more than 25 percent above the industry norm. Imperial Tobacco easily satisfied this requirement. It has a TTM payout ratio of about 56 percent, against an industry reading of 59 percent.

It is important to note that there are caveats here. Although ADRs are a good way for US investors to gain exposure to foreign firms, they also expose investors to the political, economic, and currency risks associated with foreign investments.

At the time of publication, Erik Dellith did not directly own puts or calls or shares of any company mentioned in this article. He may be an owner, albeit indirectly, as an investor in a mutual fund or an Exchange Traded Fund.

Note: This is independent investment and analysis from the investment channel, and is not connected with Reuters News. The opinions and views expressed herein are those of the author and are not endorsed by