Imperial Tobacco (LSE: IMT) has fallen behind its larger peer, British American Tobacco (LSE: BATS), over the past few years. However, Imperial is now on the war path and chasing rapid growth, making it look like a better pick than its bigger rival.
Indeed, City analysts expect Imperial’s earnings per share to grow by 15% this year and another 6% the year after. As the shares are only trading at a forward P/E of around 13, investors can pick up this growth on the cheap. Additionally, Imperial’s dividend yield currently stands at 4.9%, so the company offers a perfect blend of income and growth.
British American on the other hand is only expected to report earnings growth of 5% this year. Furthermore, the company’s forward P/E of 17.2 is demanding, although the group’s current yield of 4% is attractive.
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Expanding market share
Imperial’s explosive growth is all down to an acquisition the group is currently in the process of completing.
Despite attitudes to towards tobacco changing around the world, sales of cigarettes within the US have remained relatively resilient during the past few decades. The US tobacco market is dominated by three main players, all of which are US-based. And right now, the industry’s second largest company, Reynolds American, is currently trying to acquire Lorillard, the third largest tobacco company in the US.
To get round competition concerns regarding the deal, Reynolds is selling a number of unwanted cigarette brands to Imperial and this is where the growth will come from. In total, Imperial will spend £4.2bn snapping up these unwanted brands, which will take Imperial’s share of the US tobacco market from around 3% at present, to 10%.
British American is actually Reynolds’ largest shareholder and will also benefit from the deal, although not as much as Imperial.
You see, Imperial has really nabbed a bargain here. The brands being sold by Reynolds are unwanted because their sales have been sliding rapidly for years. Additionally, Reynolds is trying to simplify its portfolio of cigarette products.
One of the brands being sold by Reynolds is Winston, a brand Reynolds has the rights to sell in the US only. Outside the US, Winston is sold and manufactured by Japan Tobacco, which acquired the international rights for the product from Reynolds decades ago.
But here’s the thing — when Japan Tobacco initially acquire the international rights to Winston, sales were sliding. However, the company found that by making a few small changes to the brand, its advertising, and promotion, sales stopped falling and started rising.
After being neglected for years by Reynolds, Imperial thinks it can do the same with Winston inside the US. So, Imperial is set to benefit from immediate growth following the Reynolds deal, and after a few adjustments to the Winston offering, has the ability to grab an even larger share of the US market.
Looking to the long-term
Still, even though Imperial is set for an earnings boost over the next three years, over the medium-term both Imperial and British American should produce juicy returns for investors. That being said, over the long-term the future of these two companies is more uncertain, as cigarette sales decline around the world.
