Citi lit a fire under UK tobacco stocks on Thursday, upgrading ratings for both Imperial Brands PLC (LON:IMB) and British American Tobacco PLC (LON:BATS) to ‘buy’ from ‘hold’ after recent falls, encouraged by a focus on next-generation products (NGPs).
In a sector note, the US bank’s analysts pointed out that many factors hit tobacco stocks last year, reaching a crescendo in December amid increased regulatory threat, worsening cigarette trends in the US, heightened worries about leverage caused by the increase in credit spreads for the groups, and the pressure from socially responsible investors.
The analysts noted that since then, credit spreads have unwound, and companies have reported US volumes that were less bad than the Nielsen/IRI data had implied.
However, despite a rebound, Imperial Brands and BAT’s are still pricing in discontinuities in cash flow, and the analysts think that their shares could rise a long way further because they believe the environment will continue to look less threatening.
The Citi analysts said: “We expect organic growth will pick up this year as NGPs sales accelerate and we think the regulatory threat will probably move away from cigarettes.”
They added: “In 2019 there are not likely to be any significant new policies on cigarettes, so we think investors will gradually get more comfortable with the current proposals.”
The analysts said they expect an even greater focus on e-vapor, which they think may be positive for BAT and Imperial Brands.
They concluded: “We think the shares could move a long way up because it’s now effectively impossible in our view to say what the ‘right’ valuation is for tobacco shares.”
Imps a “genuine turnaround story”
For Imperial Brands, which the analysts think is “a genuine turnaround story”, they raised their price target to 3,000p up from 2,700p previously.
They said: “We prefer Imperial to BAT because sales growth is likely to be almost as good in the next couple of years, NGP margins should inflect much sooner, and leverage is less of an issue.”
But they also increased their target price for BAT to 3,600p, up from 3,000p, noting that although the stock has risen by about 28% in the year-to-date, they think that is more to do with the decline in credit spreads than a reappraisal of fundamentals.
The analysts noted: “BAT has and is launching many NGPs, so we expect about 50% growth in NGP sales this year.
“In addition we expect the worries about menthol to subside. We think the new CEO’s approach will help too.”
In afternoon trading, shares in BAT were 1.4% higher at 3,133p, while Imperial Brands’ shares were up 1.6% at 2,602p.