Friday tips round-up: Imperial Tobacco, United Utilities

21st Sep 2012 06:00

Martin Deboo, analyst at Investec Securities, raises two interesting points about Imperial Tobacco. One, it is the lowest rated across a range of 30 consumer goods producers, the shares, as the graph shows, having lost 200p of their value, or approaching 8 per cent, since July. To be fair, the comparators include the posh Swiss chocolates maker Lindt, which is in a different galaxy to the makers of Golden Virginia tobacco, favourite of the "roll-your-own" brigade. But the shares underperformed its only quoted rival in the UK, British American Tobacco, which has lost a little more than 4 per cent over that period. There are reasons why the two should be in retreat: a ruling by Australia's highest court in August moved forward the introduction of plain packaging laws. This is widely expected to be followed elsewhere; the UK has yet to adopt a firm view, but South Africa has said it will follow suit. However, plain packaging in the UK would benefit makers of cheaper brands, such as Imperial, Mr Deboo believes, because it erodes the value of more expensive ones. The second interesting fact is that Imperial shares have over the past couple of years tended to rise over the last four months of the year, probably because the company's September financial year-end means the shares go ex-dividend in January. Imperial shares have suffered from the decision in 2007 to pay £11bn for the Franco-Spanish firm Altadis, increasing its exposure to the Spanish market at quite the wrong time, and the corresponding rise in debt. The shares at present yield about 5 per cent for the year about to begin, but the real attraction is an eventual takeout, which has long been in prospect. A strong hold, then, says The Times´ Tempus column. Investors were concerned about trading at Imperial Tobacco over the last month, with the shares being down around 4% in the year to date. However, yesterday's update reassured, The Telegraph´s Questor team says, propelling the shares to near the top of the FTSE leader board. In the recent past there was much talk about equity markets not performing in the first decade of this century, as major indices were little changed. However, the MSCI World Tobacco Index had the highest return out of 67 groupings in the MSCI World Index in the 10 years to 2011. Investing in sin is a strategy that pays off, although -of course- past performance is no guide to the future, Questor explains. There are moves by western governments that aim to discourage smoking. Last month, Australia's highest court upheld a new government law on mandatory packaging for cigarettes that removes brand colours and logos from packaging. The UK government is considering something similar. However, growth in emerging markets should keep sales relatively buoyant - and the UK is proving resilient. Imperial shares are trading on a September 2014 earnings multiple of 11.1, which is a discount to British American Tobacco on 14.2. However, Imperial has a higher debt profile. The shares yield a prospective 4.9%. Questor last said hold in July when the shares were at £24.49. Following yesterday's statement, they are once again a buy for income it says. The City gets back from holiday, a handful of bids pop up, and the spivs start to look around for the next takeover stock. United Utilities was on the rack again, a long-term candidate in the fast-shrinking water sector ever since Hong Kong tycoon Li Ka-Shing bought Northumbrian Water in the summer of last year. Yesterday's trading update from United made no mention of the bid rumours, and rightly so. It was a steady-as-you-go statement from a company that is never going to startle the market, though it has to be said that in its earlier, more racey incarnation as an "all things to all men" utility services provider it gave investors enough shocks. Trading is in line with expectations. Revenue will be higher than last year, though depressed by the effect of customers' switching to meters, which concentrates the mind on water saving, and continuing lower demand from commercial users. Those bid rumours, which incidentally neither I nor most analysts believe, have helped shift the shares from 616p at the start of the year to 730p, up another 3p yesterday. The dividend is pledged to grow by inflation plus 2%, which puts them on a yield for this year of about 5%. Reason enough to hold, without any bid premium, Tempus believes. United Utilities, the UK's largest listed water group, saw its shares soar ahead of yesterday's trading update as takeover rumours resurfaced once again. Yesterday's trading statement did not have any mention of the chatter, and the shares edged lower. Bank of America Merrill Lynch said that a bid seemed "plausible". JP Morgan Cazenove doubts that the statement will quash the bid talk but did not "see a bid emerging in the next six months as likely." Of course, assets such as water companies are attractive for investors seeking relatively solid, long-term returns. United Utilities has around 7m customers in its catchment area - and this year is expected to make a pre-tax profit of more than £350m. That's why these utility groups are attractive for income investors. However, a share should never be bought on bid hopes alone. It is the fundamental prospects for the business that matters. Questor continues to believe that the best way to structure a portfolio is have the core as income shares, which provide dividends that can be reinvested. This compounding effect boosts returns significantly, although the strategy takes time. United Utilities shares are trading on a 2013 earnings multiple of 17.8 falling to 16.4 times. They were last tipped as a buy at 609p in February and they are up 20% since then. They remain a buy, Questor says.AB