Earlier in May this year, we suggested it was time to look at the turnaround potential for the Tobacco sector. With economic uncertainty, inflation and investor’s prioritisation of steady cash flow, the market environment looked incredibly positive for tobacco shares to flourish.
This Thursday, the UK’s second largest tobacco firm Imperial Brands LON:IMB, showed signs that its position continues to strengthen, with strong pricing and a return of duty-free cigarette purchasing leading to the confirmation of in-line results and the announcement of a GBP1bn share buyback to return excess capital to shareholders.Imperial’s decision to buy back approximately 5% of its shares in issue serves investors with a tangible milestone in Imperial’s turnaround story, as the company has successfully executed against its plan to reduce debt levels to the sustainable range of 2-2.5x EBITDA.
With Stephan Bomhard’s appointment to the position of chief executive to lead on Imperial’s turnaround in 2020, a strategy of ‘strengthening’ the company followed by ‘improving shareholder returns’ is underway, and the return of capital through Imperial’s buyback signals Imperial has moved into the next phase of its plan.
Imperial Brands sees operational success
Good results for Imperial haven’t appeared from nowhere, digging-in to transcripts from Imperial’s recent investor conference suggests that management at Imperial has been very busy steadying the ship. Management’s focus over the last two years has been on the top five markets, specifically the US and Germany, which deliver over 50% of operating income.
To improve sales and market shares in these top five markets Imperial has been focusing on two strategies – better sales execution, and the reinvestment and rejuvenation of the brand portfolio. In the US, Imperial has increased the salesforce by 25%, to have greater reach across the retail account spectrum. In the UK and Spain, Imperial has reinvested in local brands, such as the re-launch of the Embassy cigarette brand, which has been the number one driver of market share for Imperial in the UK.
Germany however, which accounts for 17% of operating income for Imperial has been a tougher market to turn. Imperial noted market share declines in Germany for over 10 years have resulted in significant share loss from a 25% share in 2010 to a 19% share as of 2020. Years of underinvestment in the marketing of key German brands and lacklustre sales channel execution resulted in a downwards spiral for Imperial’s second most important market. Despite the challenges, marketing investments and a re-prioritisation of key accounts have led to green shoots appearing in the German market for Imperial.
“The majority of our share [in the German portfolio] comes from three brands. One of these three brands is Gauloises. After quite a number of years of share decline in Gauloises, in FY22 we will actually increase market share. So, on the first of the three main brands, I see green shoots,” commented Bomhard.
A lucky strike in the US
Business in the US continues to move from strength to strength as key brands Kool and Winston grow market share aided by product placement, brand investments and an increased salesforce presence. However, results in the US have been positively impacted by the decision of a large tobacco company KT&G to exit the US market in entirety due to taxation concerns. KT&G held a significant share in the discount cigarette category, one in which Imperial held a large market share. This led to volume gains for Imperial and a positive reaction from key accounts left without stock after KT&G’s swift exit.
Leaving Japan behind
In a show of decisive strategic thinking, Imperial has also been prepared to cut loose areas of the portfolio that have been unproductive for the group. Imperial has long held a small, but not insignificant 1.2% share of combustible tobacco products in the Japanese market. Imperial had been attempting to grow this share; however, the company noted it was loss making in Japan for many years. Now Imperial will be exiting this market to prioritise capital efficiency going forwards.
Bomhard said: “So, we’re actually exiting Japan as a market, which should give investors the confidence this is a management team which is going to be guided by the numbers. That means every single market in Imperial now makes money and is cash generative.”
The details above highlight how the tables have turned for Imperial, with an element of good fortune, but also solid execution towards Bomhard’s five-year plan in which investors should start to see an increase in capital return from the business.
Imperial has caught up to its UK-listed peer British American Tobacco LON:BATS in terms of valuation, with a P/E of 8.5x expected earnings this year, however more multiple expansion could be on the horizon. For now, Imperial yields a healthy 7.5% dividend.
