Imperial Tobacco to light up tobacco sector, says Exane

Imperial Tobacco is the top pick in the sector for broker Exane, as the industry returns to "normal service" after a tough two years.

While organic trends in food, beverages and household and personal care are set to be below par again in 2015, Exane noted that tobacco, in contrast, after a tricky two years, is "already looking at a return to usual service due to volume normalisation in Europe, a benign tax picture and the resolution of several price spats".

Although the merger between US Big Tobacco players Reynolds and Lorillard dominates the debate, Exane now sees "another leg" to the organic growth story.

Market leader Philip Morris International (PMI) has recovered from a tricky organic period in 2013/14, and also rebased mid-term targets, but has been "wounded by the mismatch between its international cash flows and US dollar dividends and share buybacks".

By PMI's own admission, it is close to the upper bound of its single A credit rating, a key priority, and needs to maximise its cashflows in 2015/16. PMI has led significant price hikes in Europe and is following a similar strategy elsewhere, with a small but bold move to raise prices in Japan "adding to dynamics elsewhere".

The main beneficiaries, Exane said, will be Imperial Tobacco and Japan Tobacco.

"PMI is the leader in markets covering 50% of IMT’s profits, primarily in Europe. This underpins our bullish stance.

"For JT, PMI’s attempt to raise Japan prices without a concurrent tax hike could be a positive precedent."

British American Tobacco (BAT) has less crossover but has its own foreign exchange and merger and acquisition constraints.

Exane, which is the UK arm of French bank BNP Paribas, increased its forecasts for all four players, with currencies such as the ruble now turning for the better, and a better pricing outlook.

2016 earnings estimates for PMI were lifted 8%, 2% for BAT, 5% for JT and 1% for Imperial.