Tobacco is seen as a “safe haven” – cigarettes are about the last thing that smokers forego in a recession. But I’m concerned that Imperial Tobacco, the owner of brands such as Embassy, Rizla and Regal, is in danger of falling victim to the credit crunch. In January, it paid a whopping €15.2bn to buy its rival Altadis, the Franco-Spanish owner of Gitanes and Gauloise, and is now saddled with net debt of £12bn versus committed banking facilities of around £14bn. Usually this wouldn’t be a problem. Imperial could simply roll over loans when they fell due on similar terms, as before. But with credit so tight, refinancing is a major headache, and Imperial has to repay its banks £3bn next year and £4.2bn in 2010. As well as this £7.2bn cash outflow, around 70% of its loans are in euros and 10% in dollars. Since its last trading statement in September, sterling has lost 15% against the greenback and 8% against the euro.
Imperial Tobacco (LSE:IMT), rated a BUY by Dresdner Kleinwort
We’ll need to wait for exact details at its preliminary results on 25 November. I suspect this adverse currency movement has grown the debt by another £1bn. If the Bank of England keeps slashing borrowing costs, we could soon see parity between the pound and the euro. By my reckoning, that could mean Imperial’s £14bn facilities are exceeded. In this scary scenario, I’m sure the board would be forced into an emergency rights issue to protect its credit rating (already just one notch above junk). The question is: how much would it have to raise? My guess is that as a condition of rolling over the loans, lenders would insist on a maximum debt to EBITDA multiple of about four times – cutting its banking facilities to around £10bn, and triggering a dilutive £4bn fund raising.
Imperial also faces a struggle if it is to deliver its operating targets: it still has much to do to achieve the €300m a year of synergies promised from the Altadis deal. These depend on the firm’s ability to cut jobs and shut factories in unionised countries such as France and Spain. And earlier this year, in a new attempt to curb underage smoking, the British government proposed a set of initiatives that could hit the tobacco industry hard. The legislation bans packs of ten cigarettes and removes vending machines from shops. This would have a disproportionate impact on the firm because Britain accounts for about 22% of its profits. Given the risks, the stock isn’t cheap. At current levels, the shares trade on a stretched 2008 EV/EBITA multiple of 12.5 times. I would value them at nearer £9 each. It’s time to sell.
Recommendation: SELL at £15.79
• Paul Hill also writes a weekly share-tipping newsletter, Precision Guided Investments.