Bid Watch: Imperial Tobacco under pressure but tipped as target

As merger and acquisitions activity continues to pick up across global markets, a new Citywire series looks at some of the stocks that could find themselves subject to a bid approach.

It has long been considered likely that there will be one more big consolidation in the tobacco sector and some smart analysts are tipping Imperial Tobacco to be the one taken out in a deal that could potentially involve Japan Tobacco and BAT.

Nomura's European strategy team has highlighted the fact that companies acquiring other firms in Europe have outperformed by 3.4% in the year to date while the bid targets themselves have outperformed their respective markets by 22% in the 28 day period following the approach.

It has drawn up a basket of 30 stocks that it anticipates could be subject to an approach in the weeks and months ahead. What is striking, is that 18 of the 30 are UK - listed companies.

First in the spotlight is Imperial Tobacco Group.

Underperformance

Imps is the fourth biggest tobacco company in the world, after Reynolds, Japan Tobacco and FTSE peer British American Tobacco. But it has become vulnerable to persistant rumours of an approach as it has underperformed the FTSE by some 6% in the year to date. Moreover, it has underperformed its larger UK rival BAT by 20%.

Imps, which itself bought Gallagher and Spanish tobacco group Altadis in the last four years, has been hurt in the last few months by sales volume falls in Russia, Spain, Ukraine and the United States as smokers have generally downgraded to cheaper cigarettes in the slowdown, but also due to the huge rise in the counterfeit cigarette market.

The company has just issued its fourth quarter update and has cautioned that its full year revenue target for cigarette volumes are down 4.3%, consistent with a nine month fall.

However, overall annual revenues were expected to be up 3% and shares were up 1.5% on the day (22 September) at £19.22. A rise in sales of loose leaf tobacco from brands such as Golden Virginia and Drum had offset falls in volume elsewhere.

BAT 'better value'

Investment advisor Nick Raynor at the Share Centre reiterated his belief that BAT was a better and more defensive pick in the sector, despite Imp's on target update.

He said: 'We continue to list Imperial Tobacco as a ‘sell’ for investors as we favour British American Tobacco (BAT) from the sector. BAT offers better opportunities for growth and is also paying a higher dividend.'

Broker Investec tweaked its 2010 earnings very slight downwards by 0.6%, reflecting slightly lower organic revenue growth in tobacco for the full year. However, it did not change its view, reiterating the hold recommendation and retaining its target price of 2010p.