Study On Imperial Tobacco Groups Financial Performance Finance Essay

Introduction to Imperial Tobacco Group PLC

Imperial Tobacco is one of the leading international tobacco companies which manufactures, distributes and sells a wide range of cigarettes, tobaccos, cigars, rolling papers and tubes in over 160 countries worldwide. The group also offers logistics and distribution services for tobacco and other products.

"It is the world's fourth largest cigarette company by market share (after Philip Morris International, British American Tobacco and Japan Tobacco), and the world's largest producer of cigars, fine-cut tobacco and tobacco papers." (Corporate Fact File, Imperial Tobacco Group plc.)

The Group operates 51 manufacturing sites worldwide and has around 38,000 employees. It has a successful track record of integrating its acquisitions and rapidly generating revenues. Since 1997, the group has spent around £17 billion on acquisitions, including big brands like Davidoff, Gauloises Blondes, Altadis and Rizla.

Source: Annual Report 2009

Financial Performance Evaluation: Profitability

The costs of sales and duties have increased from £16,665 million in 2008 to £21,201 million in 2009. Also the revenue has increased from £20,528 million in 2008 to £26,517 million in 2009, and this growth in revenue reflects a full year's contribution from the acquisition of Altadis cigar business, operational profits and foreign exchange benefits (Annual Report 2009, Imperial Tobacco Group plc.). Though the costs of sales for the company have increased over the year, the revenue generated shows a greater rise and thus the company boasts of a 1.5% growth in the gross profit margin.

The rise in the investment income has been approximately half the increase in the finance costs thereby resulting in the increase in the net finance costs from £850 million in 2008 to £1,392 million in 2009. This can mainly be attributed to 'Fair value losses on derivative financial instruments providing commercial hedges' which rose from £376 million to £1,250 million over the year (Annual Report 2009, Imperial Tobacco Group plc.). Also, the distribution, advertising and selling costs along with administrative and other expenses have increased marginally. All these costs affected the profit before taxation and thus the company's pre-tax profit margin showed only a nominal 0.5% increase over the previous year. The tax on company's sales also depicted a 49% rise from the previous year thereby further hampering the growth of the post-tax profit margin which only rose by 0.4% from 2008 to 2009.

Profit from operations for both the segments of the group (Tobacco and logistics), shows a considerable increase from £1,471 million in 2008 to £2,337 million in 2009, amounting to approximately 59% rise. Whereas, if we look at the capital invested in the business (comprised of the non-current borrowings and equity), it only increased from £15,914 million to £16,102 million which is a nominal 1.2% hike over the financial year. This indicates that the return on capital employed is much higher for the year 2009 (14.513%) than for 2008 (9.243%).

Due to high rise in the profit after tax in comparison to the previous year, the group has given an increased return on equity (ROE) in 2009. The ROE increased from 6.938% in 2008 to 10.265% in 2009 thereby giving the shareholders a whopping 48% increased return on their investments.

Short-Term Financial Position: Liquidity

The current ratio of the group was 0.636:1 in 2009 which was negligibly lower compared to 0.681:1 in 2008. This trend, of decreasing current assets to current liabilities, exhibited by the company over the last two years is quite low as compared to the industry standards. The liabilities of the group increased more steeply at 18.24% than the assets which increased by only 10.40% over the last year. This indicates that the group's ability to meet its short term financial obligations is not adequate enough.

The liquid or acid test ratio also represented a similar trend in the financial period considered. It declined from 0.385 in 2008 to 0.380 in 2009.

However, it can be argued that while there are not enough liquid assets, the operating profits are adequate to pay off the group's short term debts.

In terms of efficiency, the group showed an improved performance over the financial year. The inventory held was sold out in 50 days as compared to nearly 63 days in 2008. The exception to this is the 'leaf tobacco inventory' which is classified as a current asset according to the industry standard but some part of it is not consumed within one year. "Leaf tobacco held within raw materials inventories at the balance sheet date will ordinarily be utilized within two years" (Note 12 - Inventories, Annual Report 2009). Hence, if this is excluded from the inventory, the inventory days would reduce further.

Also, the trade receivable days of the group reduced significantly from 47.4 in 2008 to 37.6 in 2009, illustrating the fact that fewer funds were tied up with debtors for each £1 of sales in 2009 than in 2008.

The balance sheet and income statement of the group highlight that the business took lesser time to pay its trade creditors. The trade payable days reduced to 21.5 in comparison to 24 days in 2008. On the face of it, this seems to be beneficial in terms of supplier goodwill and to strike a balance between the receivables and payables days.

5. Long-Term Financial Position: Gearing

Imperial Tobacco Group is highly geared. The annual report suggests that the business is majorly financed by debt and non-current borrowings, though the borrowings have decreased in comparison to previous financial year. The gearing ratio of the group tells us that the debt to equity has decreased from 150 percent to 144 percent this year. Similarly, the net debt to equity has dropped from 140 percent to 128 percent. Though there is a slight reduction, the level of debt in relation to the equity still remains quite high which, for this year, can be attributed to the strengthening of both the Euro and the US dollar against Sterling.

Also, the interest cover of the group has reduced from 1.1 times to 0.9 times. In the previous year the business was still in a position to pay off the loan interest from the operating profits, but this year since the finance cost has approximately doubled, the profit is insufficient to cover the interest payments.

The group's interest income has increased significantly compared to last year because of which the net interest payable has reduced. Even though the net interest cover has fallen from 1.73 times to 1.68 times this year, the group is still in a position to meet the requirement of net interest payable using its operating profits.

Cash Flow

The business mainly remains cash generative and the "group converted 128 percent of their adjusted profit from operating activities after net capital expenditure into cash, as a result of significant working capital savings of £985 million" (Annual Report 2009, Imperial Tobacco Group plc.). The strong cash flows from the group's operating activities have also helped in offsetting the debt.

As can be seen from point XV in the appendix of the report, the cash flow per share approximately doubled from 159 pence in 2008 to 334 pence in 2009.

Net cash flow from operations was strong (£3569 million), much larger than the profit for the year (£677 million), after taking into account the dividend paid. This would be expected because depreciation is deducted in arriving at profit. There was a general tendency for working capital to absorb some cash. This is not surprising since there has been an expansion of activity, in terms of sales growth, over the year.

There were net outflows of cash for investing activities, though much less as compared to the previous year due to significantly lesser cash outflow in acquisitions.

The increase in the borrowings has been quite less as compared to last year and there has been a major outflow of cash for repayment of borrowings. With the increase in the investment income, there was a significant shift in the equity/borrowing balance. During the year Imperial Tobacco successfully raised £3.9 billion through the capital markets which coupled with the working capital reduction and ongoing cash generation leaves the group with no refinancing requirements until July 2012 (Annual Report 2009, Imperial Tobacco Group plc.).

Attractiveness of the Group's Equity Shares - Investor's Perspective

The earnings per share for Imperial Tobacco Group rose from 50.6 pence to 65.5 pence from 2008 to 2009, indicating the fact that the earnings available to the shareholders increased by about 30 percent. As mentioned in 2009's annual report of the company, its adjusted earnings per share have grown by 15 percent on a compound annual basis.

The dividend per share also showed a remarkable hike from 62.93 pence in 2008 to 73 pence in 2009 amounting to a 17 percent increase in the value distributed amongst the shareholders.

As mentioned in the Chairman's statement in the annual report of the group:

"Over the past ten years we have outperformed the FTSE All-Share Index by 286%.

With dividends reinvested, £100 invested in Imperial Tobacco ten years ago would now be worth £517 compared to just £134 invested in the FTSE All-Share Index." (Chairman's Statement, Annual Report 2009)

Total Shareholder return over the past ten years

Graph showing Imperial Tobacco Group PLC's performance against the FTSE All-Share index for the past ten years

Source: Imperial Tobacco Group, Annual Report 2009

Although the dividend yield increased to 3.18 percent, the dividend cover of the business remained constant over the year at 1.1 times.

The price per earnings ratio of the group was 29.75 times, which reveals the fact that the capital value of the share is quite high compared to its current level of earnings. This reflects the market confidence concerning the future of the business and that the investors are prepared to pay more in relation to the earnings stream of Imperial Tobacco Group. But this value has dropped by 30 percent over the fiscal year. Similarly, since the market price of the share has not risen significantly in comparison to the remarkable increase in the cash flow per share, the price to cash flow ratio also dropped from 11.30 pence to 5.65 pence in 2009.

Overall, the sales volume of the group has fallen in Russia, Spain, Ukraine and the US due to the rise in the counterfeit cigarette market and also because smokers generally have switched from cigarettes to cheaper tobacco in the economic slowdown. The price to earnings ratio and the price to cash flow ratios have also fallen significantly. On the other hand, the company still has a good dividend yield and strong profitability from operating activities. The PE ratio also suggests that the stock might be undervalued.

Hence, considering all the parameters on the whole, it is recommended for the existing shareholders to hold their investment. For those who are yet to invest, British American Tobacco (BAT) would be a better option in the same sector as it offers healthier growth opportunities and higher dividends.

Conclusion

The financial performance of Imperial Tobacco Group has improved over the financial year in terms of profit margins and returns on equity. Although the company has increased its efficiency and repaid a substantial amount of borrowings from the operating profits, the augmented liabilities have reduced its liquidity. The increased losses on derivative financial instruments coupled with significant borrowings have also had a negative effect on the interest cover. Cash flow from operating activities has approximately doubled helping the business to offset its debt. The company has provided an increased dividend and earnings per share but the price to cash flow has drastically reduced, thereby rendering it a less lucrative investment for potential investors.

Appendix

PROFITABILITY RATIOS

I Gross Profit Margin = Gross Profit/Revenue x 100

2008 GROSS PROFIT MARGIN = 3,863/20,528 x 100 = 18.818%

2009 GROSS PROFIT MARGIN = 5,316/26,517 x 100 = 20.048%

II Pre-Tax Profit Margin = Pre-Tax Profit/Revenue x 100

2008 PRE-TAX PROFIT MARGIN = 621/20,528 x 100 = 3.025%

2009 PRE-TAX PROFIT MARGIN = 945/26,517 x 100 = 3.564%

III Post-Tax Profit Margin = Post-Tax Profit/Revenue x 100

2008 POST-TAX PROFIT MARGIN = 441/20,528 x 100 = 2.148%

2009 POST-TAX PROFIT MARGIN = 677/26,517 x 100 = 2.553%

IV Return on Capital Employed = Operating Profit/Total Capital Employed x 100

2008 RETURN ON CAPITAL EMPLOYED = 1,471/ (9,558+6,356) x 100 = 147100/15914 = 9.243%

2009 RETURN ON CAPITAL EMPLOYED = 2,337/ (9,507+6,595) x 100 = 233700/16102 = 14.513%

V Return on Equity = Profit after tax/Equity x 100

2008 RETURN ON EQUITY = 441/ 6,356 x 100 = 6.938%

2009 RETURN ON EQUITY = 677/ 6,595 x 100 = 10.265%

LIQUIDITY RATIOS

VI Current Ratio = Current Assets/Current Liabilities

2008 WORKING CAPITAL OR CURRENT RATIO = 6,579/ 9,658 = 0.681 times (or 0.681:1)

2009 WORKING CAPITAL OR CURRENT RATIO = 7,263/ 11,420 = 0.636 times (or 0.636:1)

VII Acid Test Ratio = Current Assets excluding inventory/Current Liabilities

2008 LIQUID OR ACID TEST RATIO = (6,579-2,858)/ 9,658 = 0.385 times (or 0.385:1)

2009 LIQUID OR ACID TEST RATIO = (7,263-2,925)/ 11,420 = 0.380 times (or 0.380:1)

VIII Inventory days = Inventory/Cost of Sales x 365

2008 INVENTORY DAYS = 2,858/ 16,665 x 365= 62.596 days

2009 INVENTORY DAYS = 2,925/ 21,201 x 365= 50.357 days

IX Trade Receivable days = Trade Receivables/Revenue x 365

2008 TRADE RECIEVABLE DAYS = 2,667/20,528 x 365 = 47.4 days

2009 TRADE RECIEVABLE DAYS = 2,730/26,517 x 365 = 37.6 days

X Trade Payable days = Trade Payables/ Cost of Sales x 365

2008 TRADE PAYABLE DAYS = 1,096/16,665 x 365 = 24 days

2009 TRADE PAYABLE DAYS = 1,247/21,201 x 365 = 21.5 days

GEARING RATIOS

XI Debt to Equity = NC Borrowings/Equity x 100

2008 DEBT TO EQUITY = 9,558/6,356 x 100 = 150.377%

2009 DEBT TO EQUITY = 9,507/6,595 x 100 = 144.154%

XII Net Debt to Equity = (NC Borrowings-Cash & Cash Equivalents)/Equity x 100

2008 NET DEBT TO EQUITY = 9,558 - 642/6,356 x 100 = 140.276%

2009 NET DEBT TO EQUITY = 9,507 - 1,036/6,595 x 100 = 128.445%

XIII Interest Cover = Operating Profit/Interest

2008 INTEREST COVER = 1,471/1,393 = 1.056 times

2009 INTEREST COVER = 2,337/2,572 = 0.909 times

XIV Net Interest Cover = Operating Profit/Net Interest

2008 NET INTEREST COVER = 1,471/ (1,393 - 543) = 1,471/850 = 1.73 times

2009 NET INTEREST COVER = 2,337/ (2,572 - 1,180) = 2,337/1,392 = 1.68 times

CASH FLOW

XV Cash flow per share = Cash flow from Operating activities/Total number of Equity Shares

Study On Imperial Tobacco Groups Financial Performance Finance Essay

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