Imperial’s Focused Approach Should Unlock Value

Business Strategy & Outlook

Stefan Bomhard has a new mantra for Imperial Brands: focus. The CEO unveiled a five-year strategic plan in 2021 that will concentrate investments both geographically and on emerging categories that

are likely to become the largest profit pools in the future. The plan makes sense because it essentially recognizes Imperial’s place in the marketplace–it is a fast follower, rather than a leader,

in most markets, but a highly profitable one with strong cash flow generation potential that should drive returns to shareholders higher in the coming years.

The overarching shift in strategy seems to be that investment will focus on categories and geographies where Imperial has existing strengths, and where consumer demand is likely to be strong. In

the core cigarette business, for example, Imperial prioritizes five tobacco markets (U.S., U.K., Germany, Spain, and Australia) in which it holds significant share and which in aggregate represent

more than 70% of Imperial’s tobacco operating profit. The company has lost share in these markets (except the U.S.) for several years, and increased investments behind its key brands should help stabilize volume declines. Other markets, as well as the firm’s smaller brands, will be managed to maximize cash flow. In next generation products, Bomhard plans to diversify the big bet placed on vaping by exiting vaping markets in which it has not gained traction, in order to target its investments on more profitable

opportunities. In heated tobacco, it is shifting its geographic focus from Japan, where it has very limited share and distribution structure, to Europe, where it has pockets of large shares.

The Bomhard’s plan will unlock value. By making more consumer and capability-centric investments, we expect the financial performance of the company to improve. Imperial has already ceded first mover advantage to Philip Morris International, and the strategy to improve performance seems to depend on regaining share, rather than driving category growth. This is unlikely to come cheap and may require higher spending going forward.

Financial Strengths

With net debt/adjusted EBITDA standing at 2.2 times at the end of fiscal 2021, Imperial’s balance sheet is roughly in line with most peers, including PMI, although gearing is much lower than that of British American Tobacco. The company has deleveraged from its 2015 acquisitions of U.S. assets from Reynolds American and Lorillard, and now intends to maintain an investment-grade credit rating. Imperial’s presence in developed markets makes it a cash-generating machine, even more so since the U.S. acquisitions. The firm has been operating in recent years on a strongly negative cash conversion cycle, and cash conversion has been up there with the best-in-class performers across the global consumer staples space. The cash conversion (defined as operating cash flow divided by operating income) to run close to 100% over five-year explicit forecast period. Imperial remains on course to return to a more normalized leverage position of below 2.5 times net debt/adjusted EBITDA by 2022, the company’s stated leverage target.

Management abandoned its medium-term guidance of 10% dividend growth in 2019, then went one step further in fiscal 2020 by cutting the second-half dividend by one third. With a payout ratio now below net income, the dividends to grow in line with earnings at a low- to mid-single-digit

rate. This is the right strategy because Imperial had been tying its own hands with the 10% growth guidance, at a time when financial flexibility is necessary to invest in long-term growth.

Bulls Say

The appointment of Simon Langelier, chairman of cannabis oil extract manufacturer PharamCielo, to the board of directors could open the door for Imperial to exploit more liberal legislation in the U.S.

Imperial generates some of the highest margins in the industry on its cigarette portfolio.

If plain packaging legislation spreads, Imperial, through its value portfolio, may be the manufacturer best positioned to benefit.

Company Description

Imperial Brands is the world’s fourth-largest international tobacco company (excluding China National Tobacco) with total fiscal 2021 volume of 232 billion cigarettes sold in more than 160 countries. The firm holds a leading global position in the fine-cut tobacco and hand-rolling paper categories,

and it has a logistics platform in Western Europe, Altadis. Through acquisition, Imperial is the third-largest manufacturer in the U.S. and owns the Winston and blue brands.

(Source: Morningstar)

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