Big tobacco stocks like Imperial Brands (OTCQX:IMBBY) (OTCQX:IMBBF) have experienced a couple of tough years in the market and 2019 has so far provided little relief. Quite a bit has changed since I last wrote about Imperial Brands in 2015, with the most consequential development being the rise of next-gen products like vapor devices and their impact on tobacco consumption. The resulting uncertainty over the long term prospects of the tobacco industry has exposed tobacco share prices to earnings multiple contraction, after expanding for some stocks like Altria (MO) and British American Tobacco (BTI) to well over 20x earnings in the wake of enthusiasm over industry consolidation during 2015 and 2016.
Imperial Brands’ share price never rose to equally optimistic levels but its ADRs nevertheless traded at well over $50 in mid-2016. The fact that Imperial’s ADR share price is down to $24 or so currently is primarily a result of that multiple contraction, because its earnings have held up quite well. Another factor has been the devaluation of the British pound against the US dollar, with the pound being Imperial’s reporting currency as well as the currency of its primary stock-listing in London.
Imperial’s trailing multiple on reported earnings is now down to roughly 13x, but in Imperial’s case the amortization charges against intangible assets reduce its earnings by a very sizeable non-cash amount. The underlying earnings reported by the company, taking out the amortization charges as well as some other expenses, are almost 2x higher than reported earnings, implying an underlying earnings multiple of 7x. Analyzing the quality of the underlying earnings is difficult, especially since certain expenses qualified as non-recurring by management, such as restructuring expenses, do tend to return quite often.
In Imperial’s case I therefore prefer to look at free cash flow per share, which came
