Imperial Brands PLC (IMB) Earnings Call Transcript & Summary

Great. Good afternoon, everyone. Before we begin, I'll just need to read a quick disclaimer. For important disclosures, please see the Morgan Stanley research disclosure website at www.morganstanley.com/researchdisclosures. If you have any questions, please reach out to your Morgan Stanley sales representative. So my name is David Roux, and I'm on stage today. We've got Lukas Paravicini, Chief Executive Officer; and Murray McGowan, Chief Financial Officer. Thanks for your time, gentlemen. Before we get into the thick of the questions, Lukas, perhaps I could just ask you for a brief overview of the business for those less familiar with the story.

Sure. Excellent. Thank you very much, David. Thank you very much for hosting us here. And a very warm welcome to all of you. Let me just summarize very briefly the compelling investment proposition that Imperial Brands is. It basically builds on 3 pillars. It is foremostly a sustainable value generation on our tobacco business. I think we have shown over the last 5 years that we are well capable of generating value out of our tobacco business without losing share. I think we have a great footprint in terms of our big markets, the U.S., Germany, which do half of our profit, very affordable, very attractive, including Spain, which is our third largest market. And beyond that footprint, we also have Africa, which today represents 10% of our operating profit, growing nicely. So we have a nice portfolio not too exposed to emerging markets, highly affordable, highly attractive in terms of our proposition. On top of that, as a second pillar, as a second opportunity to generate value, we have our very distinctive way how we want to build an NGP business, a next-generation product or our reduced harm product. And again, we have built a tremendous foundation. Over the last 5 years, we have doubled our business. We have grown double digit over the last 3 years. And we have grown share in all 3 categories, nicotine pouches, vape and heated tobacco. Again, a great foundation for us to go forward where we have committed over the next 5 years to grow double digit in this big category. And all this is underpinned with our consumer focus, our challenger mentality in terms of getting closer to our consumer, being a more simplified company and being more data led. And if you look back over the last 3, 4 years, we have changed 82% of our top 300 people that are new in position. Half of them come from fast-moving consumer goods. So we have a unique blend of people that understand our business, the tobacco business, but also bring that consumer insight, which is fundamental when you want to build an NGP Category and extract value. So a very simple tobacco business, NGP, underpinned by consumer centricity and our people that delivers over the next 5 years net revenue growth of 1% to 2% from tobacco, accelerated by our double digit growth in NGP. It will drive 3% to 5% operating profit and a cash that we guide the market around GBP 2 billion to GBP 3 billion every year. And that delivers ultimately what is our major guidance is the high single digit EPS. That allows us, in turn, to honor our shareholders by a dividend -- a progressive dividend, but foremostly by an evergreen share buyback over the next 5 years. And just to remember, over the last 5 years, we have delivered more than GBP 11 billion back to return to shareholders. That's, in essence, the investment proposition that Imperial has.

So the new team has been in place formally for just over 2 months now. From the outside in, the transition seems to have been managed pretty smoothly over the past year. What has been the biggest surprise for you over the past few months as you've both taken up the roles of CEO and CFO, respectively? And what are you most excited about in terms of the journey from here?

Let me start and then, Murray, you follow up. I think, to be honest, like most investors, me as an ex-CFO and as CEO, I hate surprises. So there was no surprise in the transition. It's also not a surprise because we've been in the business for 4 or 5 years. So we know the business well and the transition has been very smooth, which is very good. I personally, I'm very proud of what the team has achieved over the last 5 years, and I'm excited with the talent we have. I do believe beyond the strategic pillars of tobacco and NGP, the success is that we really understand our consumer more than anybody else and that we have a unique blend of people. And what we're looking forward going -- what we want to do going forward is really to unleash the potential by integrating people, process, technology and data much better. And I hope you'll see that in the next 24 to 36 months clearly come through.

Yes. So from my perspective, so I joined Imperial over 5 years ago and have been running the strategy and corporate development for the last 5 years until I stepped into the CFO role. So similarly, no surprises, I'm pleased to say. I think I'm really excited. We created the original strategy that we just finished, the first 5 years just finished. Actually, the last 18 months working closely with our entire exec team on defining the new strategy, which we shared with the markets at Capital Markets Day earlier this year. So what am I most excited about? It's about executing our strategy. I think it's delivering the transformation of the business and executing that strategy to deliver that compelling financial case for investors.

And you've touched on that strategy. I mean you've just recently closed out your first strategic cycle from 2021 through to 2025, and you're now on your 2030 strategy. At the highest level, what's different about Imperial over the next 5 years versus the past 5 years in terms of where the growth comes from and also how you run the business?

I think, again, it is what I said before. It is a combination of a confident evolution in the sense that we will continue to generate value in tobacco. There's no rocket science here. It's very simple. It's hugely cash accretive. We'll continue to do that, and we're good at it now. We'll build the NGP business. There's no change there either. I think what we want to see a step-up, though, is in our capability in the how we do things to get to those enabling to the strategy. And if you would -- if I may sort of highlight 2 things, it's really becoming the leaders in the consumer intimacy in the industry. We know probably more than anybody else our consumers, and we will continue to double down on that. And as I said before, we have a great opportunity to integrate process, people, technology and data and infuse more about artificial intelligence, having more of our people focusing on the consumer. That's probably where I'm most excited. And remember, in an organization where our margin structure means that every GBP 100, every $100 we sell, $50 goes straight into profit. It's not about efficiency alone. For me, that is a necessity. It's necessary, but not sufficient. So when we talk about the integration of people, process, technology, it's not just because we want to be more efficient, absolutely. But we also want to be much better prepared to capture more of the revenue. That's really where I'm excited about in the future.

Perhaps we can spend a bit of time on the combustibles part of the business and the market. So globally, industry volume declines are still elevated in some markets such as the U.K. and Australia. But you've seen some significant improvements in tobacco volumes over the past 3 years in general from minus 7% in '23 to minus 4% last year to just better than minus 2% this year. And if you look at the H2 dynamics this year, you're running at almost flat on volumes. How should we think about the longer term tobacco volume trends from here? Is the pre-COVID algo of 3% to 4% still the right framework to consider moving forward?

So I think 2 things. One, we don't guide the markets on volume. What is really important in the tobacco industry is actually that you can price ahead of volume decreases. So what you're looking for is the company or Imperial Brands being capable to price. And this is where we are really good because we have a footprint where our top markets are the most affordable markets. So where the hours you need to work for a pack of cigarettes, how you measure affordability is actually quite low. And that allows us to continue to price ahead of volume. So what is really important is this low single digit net revenue that we can do. And I think we can continue to do that over many years. Now yes, we had good volumes. I mean if you go back, you mentioned it, 7% decrease 4%, now we are minus 2%. It shows also that the environment, the sustainability of tobacco is probably much longer than most of the people think. We have guided the market this notion that tobacco will disappear tomorrow is not realistic. And you see that in that environment. Now, I would be cautious, even though we don't guide on volumes, to take the latest number as the going forward number. I would always go back to the long-term historic trend, which is probably more the reasonable trend to take.

Okay. On a related note to pricing, which you mentioned, which geographies do you see the biggest opportunities to take further pricing? And how do you manage to extract value from the combustibles businesses while also maintaining the company's focus on at least delivering stable market share year-on-year within your top 5 markets?

I think fundamentally, the tobacco value creation model is still intact. So if I look across the vast majority of our markets, we've got that ability to offset volume decline through pricing to deliver the low single digit net revenue growth in combustibles in line with the guidance we provided. If you look at our top 5 markets, which is where we talk about aggregate share, 3 of those markets remain very highly affordable markets. So U.S., Spain, Germany, your average worker can afford to buy over 4 packs of cigarettes from an hour work, so highly affordable. And so the model absolutely works in those markets. I think it's fair to say that U.K. and Australia are more challenged, primarily due to high excise in those markets, but we've managed them well for value. I think in Australia, they are approaching a plateau in terms of market size. We've certainly seen very accelerated levels of decline recently. And we will see that through the course of FY '26, but we do believe that will hit a plateau after that point. I think in the U.K., we've made more focused choice. So in the U.K., you've got both a factory made cigarette and a fine cut tobacco market. We've probably focused more on the factory made cigarette segment of markets, which is where the real value is to be created. And then as you look beyond those top 5, we've got a compelling footprint. Africa is a great example where 10% of our annual operating profit comes from African markets. We've got some great markets there that are performing very well from a volume perspective and from a net revenue growth perspective. So exciting for future potential for us.

And then just zooming into the U.S. combustibles market, I mean, we've seen signs of moderate improvements in volume dynamics in recent months. The industry now running at about a 7.5% decline over the last 3 months, by way of example. At the same time, competitiveness within the discount segments continues. And we've seen your share gains naturally moderate as you've extracted more value from that market. How do you see the U.S. combustibles market sort of going forward from here? And what do you think has driven the modest improvements so far this year in the industry? And is it related to the increased enforcement in the illicit vapes market?

Yes. I mean let me start by saying that our U.S. market is a great market. I think we've just grown last year 4.6% net revenue, underpinned by a strong pricing, which shows the model works and also enhanced by a significant growth in our nicotine pouches, which we launched 18 months ago. So a good market. And the good market is also because the U.S. remains highly affordable, highly attractive. We have a good offering at all price positions. We have Winston at the top, which we hold share. We have Maverick in the middle. We have also mass market cigars, Backwoods, which is an iconic brand, well curated, which grows nicely. And we have a good brand at the deep discount segment. And so yes, you have seen, obviously, after we've been very agile 2, 3 years ago, capturing a market share in that deep discount. Other companies now coming in there, which we expected. And you see more activities, more promotional activities. But don't forget, the deep discount is still a segment that is growing. We have Crown, which is still the fastest moving brand in that deep discount. And so we are comfortable with where the market is going. You might not see market share gains. But remember, the market share gain for us was more important 5 years ago to show that we were not the biggest owner of market share. To be honest, whether I do minus 1 bps, plus 1 bps, minus 5 bps, doesn't really change the picture. What we're trying to do is invest in our brand so we can grow our net revenue and generate value for shareholders. In regards to your illicit questions, we do see the past significant step-up in the FDA and in general. The rhetoric was always there. But we also see now action coming, much more enforcement at the ports, et cetera. We've seen some impact. You referred to the volumes coming down. We've always been quite honest saying that we'll probably see more improvement than deterioration, and this is what happened. I would expect more to come. I would be cautious to believe you could get away with this problem because where there is an illicit market, there will always be players. So I think there's a limit to what people can do, but I'm very happy to see that action is now following words than it is showing sort of the results.

And you gave some interesting detail around the African business at your full-year results, with the combustibles business benefiting from almost 4% volume growth and the region contributing 10% operating profit, as you mentioned, Murray. Can you talk us through the biggest markets there and the go-forward expectations for that business? And are you expecting to bring it into your priority markets over time?

Yes. I think, as you said, it's important. Africa is a cluster of markets rather than an individual market. And it has performed very well. So 10% of operating profit for the group comes from the cluster. I think importantly, for African markets, we take the same playbook activities that we apply in our top 5 markets and we apply it to Africa, whether it's the investment into our sales team, whether it be investment into our brands or investment into innovation to better meet consumer needs. I would say across the portfolio of markets, there can be volatility from 1 year to the next for individual markets. So we look at the cluster as a whole where we see stability and good long-term growth potential. I think to call out a couple of the markets, particularly last year we saw particularly strong growth in Ivory Coast and Burkina Faso, where we've really invested in brand building equity and see that coming through in terms of consumer performance. Really pleased with how the portfolio is developing there. And then separately, Morocco, we've done a lot of work around really understanding consumer taste profile. We launched Gauloises Rich Gold this year, so going after their consumer taste segment that was always underserved with their existing portfolio and addressing a gap for consumers. So really pleased with the performance in that market. But it's the consistent playbook that we use in those markets. And as a cluster collectively, we are excited about the growth potential.

Perhaps we can just shift the focus now to NGPs. So you delivered another year of double-digit growth in '25 and have guided to double-digit growth again for '26, which is consistent with your mid-term algo. You've had this impressive growth with Zone in the U.S. last year, but the other 2 geographies delivered less than the double-digit algo. Can you walk us through your outlook for the U.S. on modern oral growth next year, particularly as distribution gains slow and peers increasingly bring in, I wouldn't say, better products, but other products? And the -- also, can you talk us through the broader building blocks you see for delivering on that double-digit growth expectation for next year?

So yes, we'll do that. Murray will take you through a bit more on the details. Let me just step back again because this is obviously our second pillar, which we would like to see growing a meaningful business, as you said. It is a big ambition we have. It's underpinned by that double-digit growth. And it's probably good just to remind ourselves that we have a challenger mentality around that. So our strategy around the NGP is quite specific to Imperial. For one, we follow the consumer. Hence, we have an offering in all categories, okay? Because there is a different consumer in the Nordics to the -- who will use nicotine pouches to vape in the U.K. or heated tobacco in Italy, for example. So we will follow the consumer, and we study the consumer intensively to provide innovative products, and we can build brands based on their understanding and needs. We are also very choiceful. So we are the fourth largest. We are not here to build the category that is done by our competitors. They do that very well. It is also their role and it requires a lot of money. And so we will go into markets when the nicotine -- or the NGP category is established and we have a route to market. That allows us to be much more efficient with our resources and build a meaningful business around our Imperial strategy. That is different, allows us to build a meaningful business, but it's very mindful in the resources we use. Perhaps do you want to give a bit more details on this?

Yes. If you look across our different geographies, so things Lukas alluded to, in Europe, we primarily focus on vapor within Spain, France, U.K. particularly. We've got heated tobacco, which is really Italy, Central and Eastern Europe. And we just launched modern oral into the U.K., and we've got a good established modern oral business in the Nordics, which we're very pleased with the performance of. If I go away from Europe, if I look into the U.S., clearly Zone is the one we're excited about. We think we've got a differentiated product. We launched just over 18 months ago. We're now in over 100,000 stores in the U.S. We are around 2.8% share in that period, actually 4% within our footprint. So really pleased with the performance of that product and how it's appealing to our target consumers. And within AAACE, I think the last year, if we look at AAACE, we did pull out vaping from some of our Central and Eastern European markets, given regulatory change. We're excited about the potential of heated tobacco in those markets. So overall, pleased with the building block as we guided at the Capital Markets Day around the growth expectations. It does vary across categories. I think with vaping as a more mature category, we said around 3% growth outlook. Modern oral, we expected around 10%, heated tobacco around 13%. But we think we got a good platform to drive that growth and deliver well in the double-digit growth commitment that we made to the NGP.

So you recently launched modern oral in the U.K. with your Zone brand. What are your expectations for the business there in terms of like the number of outlets you're targeting by the end of the year, expectations for the brand? And what's your overall view of the market that led you to enter there in the first place?

We're very excited. And I think it is a good example of how we apply our strategy. So we've seen that the category is evolving. It is growing. We have decided to go in there because we also have a good route to market. It's obviously a big market for us. And we do that not following any product or any other products, but actually launching our distinctive product, our Zone product, which is more the Nordic pouch. Has innovation in which we call the perfect pouch. It has a different fiber material inside. It is much more smooth in the mouth. It gets a better mouthfeel. It gets a much better flavor and nicotine release. So it's an innovative, attractive product, which we have now launched. And clearly, we can leverage our route to market. So our expectation is to quite rapidly distribute those products through all the outlets we are present. But I would be also cautious. This is a third category. You have combustible, obviously, and you have vape. Nicotine pouches will grow, but it will be a smaller category than vape. So as much as we are excited, and we'll put a lot of effort behind it and you'll see significant growth over time, I wouldn't expect too much in the first year.

So shifting to the vaping category. I mean it continues to be one that is impacted by regulation asymmetry. Can you walk us through the latest you've seen in the U.S.? I recognize the vaping business there is small, but are you seeing sustained increases in enforcement against illicit products, which you mentioned briefly earlier? And in Europe, what are some of the disposable bans, particularly in the U.K. had in terms of impact to the market and to your business as you've redeveloped your offering there? And more generally, I mean, where do you expect the vaping category to stay for longer term? And do you think that these issues can ultimately be resolved effectively?

Lots of questions in one. You step back. From a regulation perspective, I think as an industry, we're used to seeing regulation. If you go back for decades, as an industry, we face regulation. So I think we are well positioned to adapt to when you see a change. If you look at the U.S. vapor market, we have seen a step-up in terms of activity on the border, and we've seen some step-up in certain states around enforcement against the illicit vape market. And particularly if you look at the example of, I think, Louisiana and Alabama, where we've really gone aggressively after that illicit vape market, you see rates of decline in the combustibles market, which are less severe than you see on average for the market as a whole. So we welcome that enforcement. We look forward to more. But as of yet, on mass, we've not had a significant shift in the impact. I think if you go to -- you pick up the example of U.K. and France, both introduced disposable bans this year. I'm really pleased with the way the business dealt with that. So we are very focused on the consumers. So we had a really strong disposable product, and we know one of the key things that attracted our consumer was the flavor delivery that we achieved through that. So we developed a rechargeable pod system, rechargeable blue pod system. We've rolled that into France and into the U.K. It's gone very well with consumers that delivers on that consumer need of wanting flavor delivery. And pleasingly for me, I think we're now -- we've grown share in the U.K. and in France through that change. And we're now a double-digit share -- over 10% share in the U.K. and France and in Spain within the vaping category. I think there is potentially more on the horizon. So we know the European Parliament's in discussions about the European Tobacco Products Directive, so we are waiting to see what comes from that. But likely that any impact from that would be towards the end of our current 5-year plan. But as I say, we're used to managing regulations, so I'm not concerned at this stage.