Imperial Brands PLC (IMB) Earnings Call Transcript & Summary

Good morning, everyone. Thank you for being here. I'm Gaurav Jain, Barclay's Global Tobacco and Cannabis analyst as well as the Head of EU Small and Mid-cap. With me here is Kim Reed, President and CEO, Imperial U.S.; and Peter Durman, Director of Investor Relations at Imperial Brands. Thank you so much for being here.

Thank you.

Thank you for having us.

So we will have a set of questions from me and then, then we will open it up for Q&A. So Kim, let's just focus on the U.S. business to begin with. A key topic in the sector is consistent decline in U.S. volumes, minus 9% year-to-date, that's on a comp, which was last year also minus 9%. And I think a lot of people thought that because oil prices were declining last year, volumes will be better, comps will get easier. But none of that has happened. So could you just help us understand what's happening in your view in the cigarette market? And when can we expect an improvement?

Very good. First of all, good morning to all. You're absolutely right. I mean we're seeing very similar declines that you just talked about being -- the category being down anywhere from 8% to 9%. And a lot of that has been driven by many of the macroeconomic challenges that we've seen across the marketplace. We've seen unprecedented inflation rates as high as 9%. It's good to see those come down to the 3% level. We've seen government surplus or benefits be reduced to our consumers. And we've seen gas prices at one point at an all-time high and it's hard to see those come down as well. So a lot of those macroeconomic challenges that put a lot of pressure on our consumer for sure. I think there are some signals that we will return back to historical levels. The fact that we've seen inflation come down to the 3%, that's a great signal in terms of where -- what the future holds. The fact that we've seen unemployment rates at a much -- at really great level, I think a great signal. We still will continue to watch interest rates, still very high at this point. But all of that said, we have fared very well, and I've been very pleased with the performance we've seen. We have performed much better than the industry decline. As evidence of our share performance very low but I'm pleased to say that we've seen another 70 basis points of share growth. And that is in great part due to we have a portfolio that ultimately meets the consumers' needs, wherever they may be in this stage, especially with these macroeconomic challenges in place. We got a part of our portfolio that addresses the premium segment if the consumer chooses to consume that part of our portfolio, all the way down to our deep discount part of our portfolio. So we feel we have a point of difference in the marketplace that plays across all price segments and ultimately meet the consumer where they are. So I think there are some early signals that the industry decline will -- you didn't return back to historical levels. I think either way, we are poised either way based on the portfolio offering that we provide to the consumers.

When you talk of historical volume declines, like what exactly it is? Is it minus 5%, minus 6%, minus 7%. A lot of investors think that disposable e-cigarettes are now having a meaningful impact on cigarette volumes. [indiscernible] growth could also be impacting. So what do you think is the secular...

Yes. I mean our internal forecast, I believe it will be somewhere around the 5.5% level based on all the factors that I just talked about. I think, again, I'll go back to -- we've done a lot of work on our portfolio really over the last 3 years as part of our strategy. And although none of us probably predicted coming out of over these unprecedented macroeconomic challenges, I'm pleased that we've done the work as a part of our strategy to make sure we've got a portfolio that meets the needs of this consumer. And we're offering them multiple choices really across all segments that we offer, but specifically within our cigarette portfolio, we've done a lot of work to make sure we've got the right focus brands across all those price segments, that we've got the right investment across those and really have upped our RGM capabilities as well to ensure that we've got the right value proposition across the segments as well as across the marketplace. So I think time will tell where the actual industry will go. But again, I feel good that we're poised to ultimate the consumer wherever they are.

Sure. You've gained a lot of share in the last 2 years because of KT&G's exit. Now probably we are coming to an end of it. But you have also gained share in the premium cigarette side of things. So it is not that you've just been gaining share on the value side of things. So can you just help us understand what you have done on the premium side of things as well? And I think Winston and Kool -- and Salem as well. They are the 3 key brands. So what has happened there and why the performance has been so strong?

Yes. So first of all, I'll start with the KT&G piece. I mean this is one we talk a lot about being a challenger within this industry. We are not the largest. We're the third tier player within the U.S. business. And we proud on having agility [Audio Gap] the difference in the marketplace. And in this case, we had an opportunity with KT&G, quite frankly, within a day announcing they were exiting the marketplace. I was really pleased with how our commercial team came together and maximize that opportunity. So yes, we did gain some share from being able to maximize not only from a brand equity standpoint, but also leveraging our expanded sales force to ensure we were able to maximize that space on shelf. So that's been a part of our share growth. But I have to tell you, part of our strategic initiatives as part of our new strategy has been investing on Winston and Kool, represents almost 50% of our portfolio. And those -- prior to our acquisition of those brands really [Audio Gap] significant declines for many, many years. We -- one of our many priorities has been starting with the consumer. And we've spent a lot of time engaging with that consumer, both on Winston and Kool to understand what are their functional needs, but also there's an emotional connection as well to these brands. And I'll use Winston as an example. And when we did a deep dive with the Winston consumers, what they told us is that we just weren't getting the level of trial that we had expected in the past. And ultimately, it was because the view was that this was an older person's brand, your grandfather's brand, your uncle's brands, those are literally the words that these -- that our consumers would tell us. And so it was a matter of then doing a deep dive on what matters to the consumer. And so we've revamped our strategy around both Winston and Kool. And so we have leveraged things like -- quality and taste were very important to them. We really have [indiscernible] both on package as well as in store directly to the consumer about it's simplest tobacco and water. That has resonated with the consumer in a really great way. This Winston consumer is all about freedom. And they're in the greatest country in the world. In their minds, that freedom, I can do what I want, I can choose the brand I want. So we've really captured that with America. We love a campaign that, again, resonates with that Winston-type consumer. We've changed our packaging. We've also really worked with our retail partners as well to leverage their adult database as well. That as we build our own internal database, we've been able to bring things like NASCAR as well, which is, again, a huge activation point for the Winston consumer. That's how Winston -- Winston is an iconic brand. It was discovered around Winston Cup Series. Obviously, regulations do not allow us to advertise that any longer, but we can do some retail partnerships with that brand, and we've leveraged that to not only then be able to speak to those Winston consumers within our customers' adult databases but then we can also speak directly to them within our own database. So that's just 1 example of how we have started over with our strategy, start with the consumer, understood what's mattered to them and then revamped our strategy at all. So we've seen actually, when you look across our entire portfolio and look where our share has come from, we're actually growing across all of our price segments, not just deep discount, not just the KT&G. We're growing from premium all the way to deep discount. I'm pleased to say when you talk about 70 basis points I just referenced a minute ago. There's only 14 basis points of that, that represents KT&G. The rest of that is coming from the work we've done across the portfolio to resonate with the consumer in a much more meaningful way.

Sure. And in terms of the California menthol ban, could you just talk about what has your experience been?

Yes. It's still a little early to really read the data. And there's a few reasons for that. As the first, pre-ban, we had a lot of consumers that stocked up a bit on their brand of choice. Then after the ban took place and you see consumers then start to go to surrounding states to find their brand of choice. You see a bit of a list of trading going on as well. So there's a lot of moving parts right now that's really, really hard to read the data -- this is an example where we -- how we leverage our global community, which we stood up again a couple of years ago led by Anindya Dasgupta. And it's really been a part of understanding ultimately leverage of some of our European markets that have already gone through a ban, and we've essentially lifted it shift to that playbook within California as well. So we've introduced non-menthol variants around Kool and Salem. We've executed on shelf with those -- with that part of that portfolio. Ultimately, we've learned from our European markets that the consumer will eventually come back to their brand. They will take a period of time because, again, they were to go to surrounding states to find their menthol choice, they may trial categories. But eventually, they will come back to their brand. It's just too early at this stage, though, because they're going through all of those cycles right now. I think it will take at least another 6 months before all of the trends really settle and then we'll have a much better read at that point in terms of how our portfolio is playing out in that market.

Sure. Now just coming to the pricing side of your cigarette business -- in the U.S. cigarette business. So for some time, in periods pricing was lagging the industry leaders, and then we have seen the pricing pick up. And now there is quite healthy pricing happening at the discount and the deep discount cigarette side, not only for Imperial, but also your other competitors. So is this now the model for the next 2 years that we have gained significant share in the U.S. cigarette market and now you're looking to monetize the share you actually had?

Yes. So first of all, say the U.S. is still -- it's a competitive market, as you know. It's still an attractive market. I mean I had the privilege of being able to lead it as our largest market across Imperial. And we have been able to leverage pricing power that still exists within the marketplace. And we've been able to do that across our entire portfolio now. You could talk about the capabilities that we're chalking around our RGM capabilities. That's been a really critical piece, a real critical capability that we brought on as part of building our strategy as well as shopping our portfolio. So being clear about the role that each of those brands plays across the price segment and do we have the right value proposition along the way. That has been a part of determining what our pricing model will look like as well going forward. We have had solid price/mix performance this year. We talked a little bit about that in the first half. I think you'll see some similar results as we get ready to report our results in October. But we want to be mindful of ensuring that, again, providing value across the portfolio for that consumer, especially one of the challenges that -- with their wallets being tied with the macroeconomic issues. But we still think that's the right portfolio to offer the premium of way to deep discount this space.

Sure. Now moving to the cigar side of your U.S. business. It's about 1/4 of your U.S. business. And just to frame, U.S. is about 1/3 of the entire company's EBIT. The cigar side has seen pressure this year. And I think -- can you just talk about, first of all, the overall industry dynamics, what's happening there? And then within that, what's happening for Imperial cigar business as well?

So our cigar business is not only important for the U.S., but it's an important business with entire Imperial. And I'm pleased to say it's -- we refer to this -- to our cigar businesses as our regional jewel, specifically led by Backwoods. It's a brand that we talk about, consumer-centric brand that we know [indiscernible] very well. We spend a lot of time doing consumer [Audio Gap] with this consumer. And so what I'll tell you is we have had a soft first half. And there's a few factors -- a few factors behind that. The first is it was Hurricane in Tampa a year ago. There was a hurricane here not too long ago. But it's been a year ago, and that created a bit of destocking with many of our wholesalers and our retailers with the belief -- with the concern that we may be out of business for a few days. So we didn't have to unwind through that stock. And I'm pleased to say that we're in a much more stable and inventory is no longer a challenge. The second piece is that we had 2 unprecedented years with COVID. And so we're now that's a very strong comparator that we're going up against as well. We also in a much better position than our competitors in terms of inventory at the time. And so we're also going up against that as a comparator as well. And then if I can share, we've a bit of a challenge because of lapping some of those inventory levels that I just spoke about. So those were a few of the drivers in the first half. I think when we announced our second half results, overall, it will still be a bit of a drag on the business in great part because of the first half performance. What I will tell you is we have seen an improvement in the second half, and we'll share those details when we get into October. And as we engage with consumers, there's been 3 or 4 things, I think, those are important: quality is very important, both in terms of color and texture and moisture. So we will continue to make -- we have the highest quality, especially because it's a premium brand for this consumer. Second thing is new news. They want to see innovation. So we've launched here in the second half Vanilla and Grape, just launched Grape 2 weeks ago, having significant uptake from that. And then certainly, we've got the right value, again, comes back to those RGM capabilities and then ensuring that we're leveraging our expanded sales force of 1,000 people in the marketplace to ensure it's on the shelf in the right places. So this business has not worked somewhat of a recent year after overlapping 2 significant years of COVID. If you were to compare our results to the pre-ban levels, we're still in a growth pattern. And feel strong that this will continue to be an updated part of our business going forward. So bit of a reset but we feel good about that there's improved performance in the second half and I feel very good about the future in this brand and this category for that matter.

Sure. Now coming to the modern oral segment, and you have just acquired a business earlier this year. Can you just tell us your thinking behind why you did that? Where we are with the PMTA process with the product? And also like do you think that you now have a complete portfolio in the U.S. or you need some other products to fill out your product portfolio?

Yes. So I'm really excited about this new acquisition. Just announced in June that we are entering the modern oral nicotine segment. We acquired brands from TJP Labs. And I'm excited about entering this segment. It's a growth part of the segment, and it ties back to our strategy, which is NGP- leveraging NGP. And what's exciting about this is we have a very strong combustible business. I'm sure we'll talk about vape here in a moment. But it gives us an opportunity to expand our NGP agenda and, again, provide potentially handful options for our consumer. And so -- earlier, our strategy is we are not the largest. We are a challenger company. So we will not lead creating demand in any market. Clearly, there is now demand within the modern oral nicotine space. And so it made sense for this acquisition to happen for us. It's aligned very much with our strategy. And it gives us now the opportunity now to create our own brand equity, which is a very similar work that I just described on Winston. We're doing the exact same consumer research to ultimately develop a brand. And then also leveraging our go-to-market model of our expanded sales force of 1,000 people to be able to take this into the marketplace. So it aligns very much with our NGP strategy of having an expanded portfolio. We will be launching in early '24, and I'm excited about sharing more of the details as we get closer to that time line. But I think to the second part of your question, this allows us to have a really complete portfolio now, right? When you think about our strategy, which is as part of our Tier 1 markets to really have a strong combustible business, but at the same time have a very strong NGP offering. And it gives us an opportunity as we start to see consumers drive a bit more poly usage, it gives us an opportunity to have a portfolio that, again, to meet them where they are. If they choose to continue to save in combustibles, we've got the right cigarette and cigar portfolio that we've done a lot of work on to date. But it now gives us an opportunity to expand our NGP offering both with vape as well as with modern oral. So we're feeling really, really great about this acquisition and we're getting plans ahead to be announced in '24.

Sure. A question on the recent U.S. Court of Appeals ruling that the FDA's MDO on myblu had failed to follow the law, and that its denial of unflavored blu products was improper. So what does this all mean for the future of blu in the U.S.?

Yes. So this has been a long time coming. I'm glad I can actually answer to this question to date. So just to take a step back, just for those that maybe aren't as close to it. April of 2022, the FDA made the decision to give us an MDO, marketing denial order. And we were obviously disappointed in that decision. And quite frankly, leveraged all of the legal levers that are at our disposable first, went through the process of submitting an administrative appeal to the FDA, indicating that we ultimately did not agree with that decision. And secondly, then we took legal action to Circuit Court of Appeals. Taking about 14 months, but just a week or so ago, we did get the final unanimous ruling that indeed the FDA acted in an unlawful way. They did not have the data of the science to support that decision because our portfolio indeed was meeting the regulatory standards -- high standards [indiscernible] with those standards. [indiscernible] portfolio [indiscernible] giving us that market power. So at this stage, the FDA has been [indiscernible] ] made that decision. And now we will continue working with our retail partners. Many of those retail partners have continued to carry our products prior to this MDO in the midst of -- we have rolled out a new brand equity program. We had changed the packaging [Audio Gap]. So a lot more to come out in that space. Really, really pleased with the decision. And, again, this goes back to our NGP strategy for the U.S., which will be focused around vape and modern oral. And yes, we think this gives us a whole [indiscernible] portfolio to engage with consumer no matter where they may be across the spectrum.

Sure. So Peter, now just talking about the overall Imperial. So there is a guidance in the multiyear guidance that has been laid out. And this year, the guidance is that EBIT growth will be somewhere around 3.5% and then it accelerates next year and then it accelerates for the year after. How confident do you feel about that given all the volume pressures we have seen on the U.S. cigar side of things. And yes, you're doing better on the U.S. cigarette side of things because of share gains. But probably this does concern you somewhat the overall state of the U.S. cigarette industry. So how should we think about the multiyear guidance right now?

Sure, yes. I mean we'll -- just as a reminder, we will make sure trading update on the beginning of October, October. But in terms of the multiyear, we're still on track. We still believe that the things we're doing around the strategy is driving the operation improvement. If you stand back and think about what the strategy was [indiscernible] driving a better share performance [indiscernible] share declines in the top 5 markets. And we've done that. And we've managed this well alongside that to achieve pricing. So one of the big themes of this year has been very strong pricing that you've seen across the portfolio. So although the volumes have been under pressure, you'll still see that the top line has held relatively well and then that's translating down into the EBIT growth you're seeing. So, look, I think we -- like Kim has talked a little bit about the U.S. We hope that some of the volume pressures you see elsewhere will start to ease. Certainly, that has been the case in some of the European markets already. Some markets still a bit of a challenge. The U.K. market, we know there is higher excise and so on, the volume pressure is there still. But on the whole [Audio Gap] from these European markets and [indiscernible] region, those we have started to see volume improved a little bit in the second half. And then coupled with the very strong pricing that you saw in first half and that's carried into the second half. That's also helping to offset that. So I think one of the things we've done through the strategy is improve the resilience, I think, of the business that is better able to manage some of these shocks than we might have been in the past. And that's a function of this sort of very disciplined approach that we've had across every market like the U.S., but also other top 5 markets we have [indiscernible].

Sure. And let's -- if we just talk about a few of these key markets. So you highlighted U.K. market volumes are still under a lot of pressure, down 15% probably right now. And then next year, again, there will be [indiscernible] 3% sort of excise tax increase, which is the formula by the U.K. government. So that market seems to be under structural pressure. And in Germany, which was just the largest market after the U.S., you continue to lose share, but the market growth is itself quite strong right now. So I think that is just helping all the manufacturers grow in Germany. And then Australia seems to be coming back after a few years of pressure. And Spain continues to hold on pretty well. So when we add -- all these different percentage, do you think outside the U.S., the business can grow low to mid-single digits because the U.S. business the way we take, some things can grow mid to high single digits because of all the shares gains which have happened on the cigarette side of things.

Yes, I think we do. So I think, again, it's worth sort of separating out the markets a little bit. So with the U.K. and Australia, just because of the dynamics of those markets, we've always taken -- even when we set out the plan, if you go back to the strategy document in January 2021, you'll see that we took a relatively cautious assumption about those market outlooks. We actually expect the overall sort of revenue quarter to shrink over time, partly because of the volume pressure, the increasing challenge of offsetting that through pricing. Actually, in the U.K. market this year, we have taken -- we did lead on pricing in the U.K. And we [indiscernible] but it has meant that the value taking the market has been good. And that follows 2 years of share gains. So I think there's always this balance is there between what we do with share and what we do in terms of pricing. And having had 2 years of share gains, we were able to monetize some of that share gain with pushing through on price in the full knowledge that would have pressure on share. Spain has been encouraging because we've had now 2 years of price increases for the first time in a long time, which is really good. Germany, the overall market remains very attractive as a cigarette market. Volume declines are relatively modest. And the ability to take pricing in that market has been good to the overall characteristics of the market. It's very good to cigarettes remain very affordable. The challenge as you say is that we've lost share, we continue to lose share, and that's turning that share around has been a bit more of a challenge than the other markets. But that was what we always said. If you go back to the strategy where we set out in January '21, we always said that Germany would be the toughest to turn. It's the one that have been declining for -- the longest declining for more than 10 years. And -- but the things we're doing in Germany are no different from the things we're doing elsewhere. So all the sort of playbook that we've been using in the U.S. you heard about very similar initiatives, we're playing there. It's just taking longer just because of the scale of historical investment the challenges making -- driving through some of the changes, which has taken a little bit longer in a market like Germany versus a market like the U.S. So I think overall, to come to your question, I think we're still confident that the top -- the focus on the top 5 is right. The things that we're doing in those markets is good, is driving. And if you remember as well, we had a relatively cautious assumption that our objective to hold our share in those top 5 markets, actually, if anything, you've been doing a little bit better than that in terms of growing share. And we've always said we won't grow market share in all of the any 1 year. It's always a bit of -- there's always a portfolio, some will be a bit ahead, some will be a little bit behind. But I think in terms of where we are, where we thought we were going to be, we're very much on track and if anything, slightly ahead. And that gives us the confidence that we can sustain that into the future.

Sure. Coming to NGP, it's about $200 million, $250 million in revenues. It is growing nicely. You have launched heated tobacco products in a number of countries. [indiscernible] launched blu bar in a number of countries. And then you also have modern oral business, which seems to be growing quite nicely in Europe along with what's happening within the category. So how should we think about your NGP business? And is that something which you can continue to grow in aggregate at this 20% top line for the next few years?

Yes. So I think -- so look, the NGP is developing a sustainable growing business is another key pillar of our strategy. And I think it's important perhaps to take us a little bit of a step back. If you think about at the beginning when we started on this new strategy, I think one of the things that was very clear is we had to test and learn a lot about the products. We had to test. Do we have products here that we can that appeal to consumers efficiently? Do we have a model that allows us to launch those to market successfully. And if you recall, one of the big shifts of the strategy was to move heated tobacco out of Asia, move it into Europe for the first time. We did it very much on a trial basis. So the start of the first year or 2 of our NGP story has been about testing, trialing, pushing it back into Eastern Europe. It's been about trialing with blu, changing the proposition around blu there. And also trialing a new innovation approach. So we've again completely revamped how we do innovation. I think what you can see in this past year is the fruits of that starting to come through. So we've had a complete revamp of our portfolio this year. So we've launched new versions of the Pulze product, which are heated tobacco products, new versions of our pod offer, which is blu 2.0 and also a completely new disposable category that you [ didn't ] had before and also new variants around the modern oral products. So the product -- the NGP portfolio is completely refreshed in the past year or so. And then on top of that, we've also started to scale in terms of market launches as well. So you've seen the step up in terms of market launches across each of those categories. So what's encouraging is you now started to see a broader base of growth across each of the categories and, of course, geographically as well. And also the other part we wanted to prove out is that we were able to do that with relatively more distinct investment to go back to to sort of this challenger approach. We're not seeking to develop markets from scratch. It's more about being offering consumers choice in existing markets. And that, I think we've -- this year, again, you'll start to see that prove out in the -- in terms of what you're starting to see good top line growth with relatively modest additional investments to achieve that. So I think setting on the right course basically.

Sure. And coming to now the very interesting question around capital allocation. So dividend growth you have said it's going to be in line with EBIT growth, not EPS growth. That's the...

I mean, we've said -- what we said is the dividend policy is a progressive policy. That means the dividend will grow each year. And what we said was grow in taking into account underlying business performance. Now the Board -- ultimately the Board will decide where to pitch in that level, whether it's near EBIT growth or whether it's near EPS growth. For the time being, you'll see that the Board has decided to pitch in near operating profit growth because that's a sort of [indiscernible] generation of the business. So that's a sustainable ongoing basis. But clearly, ultimately the Board can tweak it accordingly. But that's where we've been at the moment in recent times, yes.

Sure. But because of share repurchases, which are now happening, your EPS growth will be higher than dividend per share growth, which means that your dividend payout ratio keeps progressively reducing and the gap between free cash flow and dividends progressively increases. And the free cash flow is also growing because your EBIT is growing. So last year, you did GBP 1 billion of share repurchase. So how should we think about share repurchases for FY '24? And would you like to maintain a constant leverage ratio of 2x? Or will it just down to 1.8, 1.7.

So I think maybe just take a step back in, maybe, just in terms of the overall forecast. Obviously, alongside strategy, we set out a very clear capital allocation priority and the first of which is to invest in the business. That's mainly an organic strategy, relatively low CapEx requirements, but some bolt-on M&A. And we touched a little bit earlier, for example, like the modern oral acquisition in the U.S. market. On your debt question, second priority is about maintaining leverage at the lower end of our 2, 2.5x range. We expect to be there at the end of this year. So around hover around the 2 level. Progressive dividend, we've talked about. And then in terms of the buyback, really, the principal buyback is that any surplus cash flow that we don't need for anything else in meeting the first 3 priorities, we will seek to return it. The thing I would just highlight though is that we would have to keep a little bit of headroom in place for things like a little bit of M&A, all those small bolt-ons and also uncertainties as well. So it's balancing those things out there. And so I can't -- again, ultimately, the Board will decide where it pitches the buyback level. We did GBP 1 billion last year. There is scope to grow that this year. I think at the moment, there's quite a wide range of your consensus ranging from some GBP 0.5 billion to GBP 1.5 billion. I think most people are sort of sitting around the GBP 1 billion to -- sorry, we had GBP 1 billion to [ GBP 1.3 billion ]. I think the absolute at average is about GBP 1.1 billion, GBP 1.15 billion. And I think what we want to do is do the right thing. We want to -- the most important value you get from the buyback is not so much about whether it's GBP 1 billion or GBP 1.1 billion or GBP 1.2 billion. It's the fact that we've made this ongoing commitment that we will consistently do a buyback every year that will buy back a meaningful portion of the share capital. And that's where we see the real value from the buyback coming.

Sure. I think we are out of time. Thank you so much. We will have a breakout in the next room. So please do join us.

Thank you.