Imperial Brands (LON:IMB) is deep in the midst of a tobacco industry which is undergoing significant change, with the race to Next Generation Product (NGP) growth central to its plans.
The pressure on traditional tobacco products has been in evidence for some considerable time, driven both by changing lifestyle habits as well as increasing regulation. A more recent volley came from the UK Prime Minister with plans to incrementally ban tobacco sales, especially to youngsters, resulting in share price declines across the sector when it was announced. This adds to the burden of regulatory censure which has plagued the sector over recent years, a general decline in traditional tobacco products sales as health issues come to the fore and a reluctance among some investors to invest in tobacco companies at all on ethical grounds.
At the same time, the need for a long term replacement for traditional combustible products left the tobacco majors needing to move from a standing start, and even after some years of development the NGP unit is still loss-making for Imperial, although there are clear signs of growth. Whether the growth can be continued at a pace which can even begin to offset the decline in combustibles remains a core question overhanging the sector, let alone whether the current levels of margin and profitably can be replaced.
In the meantime, Imperial continues to play the cards it has been dealt. Its traditional business has maintained growth for the period, with low to mid-single digit improvements expected for both revenue and adjusted operating profit. Tobacco remains a product which has inelastic demand, providing the ability to raise prices without unduly dampening demand and this pricing mix has seen the benefit as a result, with falling volumes more than offset by higher prices.
Imperial is also tailoring specific brands to specific regions, even within countries, which has had some positive results. The group continues to focus investment in its top five combustible markets, which account for around 70% of overall operating profit, and where growth in the US, Spain and Australia is more than compensating for declines in the UK and Germany.
The cash generative nature of the business, despite the current foreign exchange headwinds which are expected to shave up to 5% from adjusted operating profit in the first half, is also allowing some financial largesse in terms of shareholder returns. The latest share buyback programme of £1.1 billion is on track to complete by the end of October, while a dividend yield of 8.5% is punchy by any standards and is a clear attraction given the general rate of returns to be found elsewhere. The group plans to make shareholder returns a particular feature over the coming years which, all things being equal, should be supportive for the share price.
The race to dominate the burgeoning NGP market is one where Imperial’s size could work against it compared to its peers, but where progress is certainly being made as the landscape evolves. In the latest period, revenues are expected to have grown in the mid to high-teens percentage rate, with improving gross margins accompanying reducing operating losses. The group now operates in 20 European markets as well as the US, rolling out new products which have had varying degrees of success by region.
The summary for the period reveals that Imperial expects operating profit for the half year to exceed that of the corresponding period, driven largely by higher pricing and net revenue growth for NGP. The group retains its ability to choose between shareholder returns, investment in the business, paying down debt or any combination of these. The share price has inevitably been under some pressure, having dropped by 9% over the last year, as compared to a gain of 2% for the wider FTSE100, although outperforming its larger rival British American Tobacco (LON:BATS), which has seen a decline of 18% in its price over that period. Indeed, while the recent share price movement might suggest some caution, the market consensus of the shares as a buy suggests a dogged resistance to the current challenges, based on prospects for a burgeoning NGP market and ample shareholder return rewards in the meantime.