Is Imperial Tobacco The Ultimate Retirement Share?

Published in Company Comment on 3 October 2012

Will shares in Imperial Tobacco help you build a FTSE-beating retirement fund?

The last five years have been tough for those in retirement. Portfolio valuations have been hammered and annuity rates have plunged. There's no sign of things improving anytime soon, either, as the eurozone and the UK economy look set to muddle through at best for some years to come.

A great way of protecting yourself from the downturn, however, is by building your retirement fund with shares of large, well-run companies that should grow their earnings steadily over the coming decades. Over time, such investments ought to result in rising dividends and inflation-beating capital growth.

In this series, I'm tracking down the UK large-caps that have the potential to beat the FTSE 100 (UKX) over the long term and support a lower-risk income-generating retirement fund (you can see the companies I've covered so far on this page).

Today, I'm going to take a look at Imperial Tobacco Group (LSE: IMT), the UK's second-largest tobacco company.

Does Imperial beat the index?

To start with, let's take a look at how Imperial Tobacco has performed against the FTSE 100 over the last 10 years, on a total return basis:

Total Return20072008200920102011Trailing 10 yr avg.
Imperial Tobacco38.1%-29.1%9.4%4.3%28.2%11.4%
FTSE 1007.4%-28.3%27.3%12.6%-2.2%7.8%

Source: Morningstar

(Total return includes both changes to the share price and reinvested dividends. These two ingredients combined are what make it possible for equity portfolios to regularly outperform cash and bonds over the long term.)

Imperial Tobacco has outperformed the FTSE 100 over the last ten years, delivering an average of 3% extra total return each year. However, Imperial's larger UK peer, British American Tobacco (LSE: BATS) (NYSE: BTI.US), has delivered much greater returns, highlighting the benefits of its greater focus on emerging markets.

What's the score?

To help me pinpoint suitable investments, I like to score companies on key financial metrics that highlight the characteristics I look for in a retirement share. Let's see how Imperial Tobacco shapes up:

ItemValue
Year founded1901
Market cap£23.4bn
Net debt£9bn
Dividend Yield4.1%
5 year average financials
Operating margin18.4%
Interest cover4.0x
EPS growth16.2%
Dividend growth12.1%
Dividend cover1.8x

Source: Morningstar, Digital Look, Imperial Tobacco

Here's how I've scored Imperial Tobacco on each of these criteria:

CriteriaCommentScore
LongevityA genuine blue chip.5/5
Performance vs. FTSEIt's beaten the index over the last ten years.5/5
Financial strengthOk, but quite a lot of debt and falling margins.3/5
EPS growthSlowing, but remaining ahead of inflation.3/5
Dividend growthRobust and attractive.4/5
Total: 20/25

Imperial Tobacco's score of 20/25 suggests that it could be a strong candidate for a retirement fund portfolio. However, Imperial is playing catch-up with British American Tobacco in emerging markets and is struggling to maintain its margins in mature and more heavily-regulated western markets.

My choice of tobacco share would be BAT, which I feel offers better growth prospects and a more reliable income than Imperial. On the other hand, Imperial currently trades on a fairly attractive P/E ratio of 12.2, making it significantly cheaper than BAT's P/E of 16.4.

Both shares are attractive investments, and you may be interested to learn that both Imperial and BAT account for a big portion of City legend Neil Woodford's funds -- the man many see as the UK's answer to Warren Buffett.

Woodford's other shares

Neil Woodford's dividend stock picks outperformed the wider index by a staggering 305% in the 15 years to 31 December 2011, and he now manages more money for private investors than any other City manager.

Imperial Tobacco and BAT are two of Neil Woodford's top eight holdings -- and if you would like to learn about the other shares he has chosen and how he generates such fantastic profits, then I would strongly recommend this free Motley Fool report.

In the report, we explain how he chose some of his biggest holdings, many of which are excellent retirement shares, in my opinion.

This report is completely free and I strongly recommend you download "8 Shares Held By Britain's Super Investor" today, as it is available for a limited time only.

Warren Buffett buys British! The legendary investor has recently topped up on his favourite UK blue chip. Discover what he bought -- and the price he paid -- within our latest free report!

Further investment opportunities:

> Roland does not own any of the shares mentioned in this article.

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