UBS hikes Imperial target on US tobacco deal potential

UBS has hiked its target price for Imperial Tobacco by 15%, saying that it sees the prospect of a “significant step-up” in cash flow at the cigarette company.

The bank lifted its 12-month target for the shares from 2,900p to 3,350p and reiterated a ‘buy’ rating.

Imperial is looking to buy £4.2bn of assets from Reynolds and Lorillard as the US tobacco giants shed brands to get clearance on their proposed merger.

UBS believes the tie-up will complete in the second quarter of this year and will trigger Imperial’s purchase and “a combination of greater leverage, cheap debt (a coupon of 2.35%) and tax shield means this acquisition should be very accretive to Imperial’s cash flow”, it said.

Furthermore, the bank believes that Imperial will likely consolidate all its US cigarette production at the ex-Lorillard Greensboro facility in an effort to make “significant cost savings”.

UBS estimates that the acquired assets should contribute $680m to Imperial’s operating profits by the financial year ending September 2016, rising to $800m once a reciprocal manufacturing agreement ends with Reynolds in two years’ time.

The bank said: “A […] contribution of $800m would on a pro forma basis increase Imperial’s equity free cash flow yield to almost 7% (versus the consumer staples sector average of 4%) and underpin management’s medium target of 10% per annum (sterling) dividend growth.”

Despite the positive comments, the stock was down 0.6% at 3,142p by 10:56 on Friday.