Introduction and Business Overview
Imperial Brands is a Company dedicated mostly to the manufacture, marketing, and sale of tobacco products. The company was founded in 1901, has a current market cap of GBP 14.788 billion, 32,500 employees, and annual sales of GBP 16.6 billion in 2020. According to its market shares it is the fourth largest tobacco company in the world after Philip Morris, British American Tobacco, and Tobacco International (Tobacco Tactics, 2021).The company has three main lines of business: tobacco, NGP (Next Generation Products), and distribution. The tobacco segment manufactures, markets, and sells cigarettes, rolling tobacco, rolling papers, and premium tobacco (cigars), although Imperial has had to sell the premium tobacco business in 2020 to pay down some of its debt. Some of the most well-known tobacco brands of Imperial Brands are Davidoff, JPS; Gauloises Blondes, West, Winston, and Parker & Simpson. The NGP segment includes products like “heated-not-burnt” tobacco (Pulze), vapes (Blu), and other products like chewing tobacco and snus. The third and final segment is the distribution segment, which is made up of a subsidiary called Logista. Logista is publicly traded in Spain and is dedicated to the distribution of tobacco products, pharmaceutical supplies, and other products in Southern Europe. Logista’s profitability margins are obviously much lower than those of the tobacco business and it contributes arount 7% of the total operating profit of the group, making it a rather small share of Imperial Brand’s business. Finally, Imperial Brands is still a tobacco-centered business, with 87% of the company’s sales coming from its tobacco segment. Around 2% of 2020’s sales came from the NGP segment and the remaining 11% came from Logista.The company’s core markets around which its current strategy is focused are the USA, Germany, the UK, Australia, and Spain. Tobacco and NGP sales are distributed geographically this way: 45% in Europe, 31% in the Americas (mostly the US), and 24% in Africa, Asia, and Australasia. It is also worth mentioning that the company’s sales are fairly concentrated, as more than 70% of sales come from the aforementioned core markets. Here it is important to highlight the risk that regulation plays in the tobacco industry, as companies are at the mercy of regulators. For example, recently in the US, the sale of flavored liquids for vapes has been banned, which forced Imperial to write-down most of the value of its inventories of this type of product.Recent Struggles
In the last 5 years the company has not been operating very well compared to its competitors as it has been losing market share in most markets, it has had to write-down several investments due to regulation, and it hasn’t been able to make the NGP business take off. Given these issues, the CEO since May 2010 quit and a new CEO, Stefan Bomhard, was hired in July 2020. Stefan comes from being the CEO and a high-ranking executive of several companies and has lengthy experience in marketing and brand-building and is the first outsider CEO the company has appointed in its 120-year history. The company’s chairwoman has also been a new addition to the team in January 2020, although she had been a member of the board for a few years. With these new two additions the company published in January 2021 its plan to turn around Imperial Brands into the “correct” path. After a careful strategic review Stefan Bomhard decided that the best path moving forward is to focus first in the tobacco segment in the 5 core markets. Despite this focus on the traditional activity of Imperial Brands, the company also plans to keep up investments in the NGP portfolio, although with much more care and thoughtfulness than the previous administration in order to repeat the losses and write-downs seen in the last few years. Finally, it is important to mention that the company is also focused primarily on the reduction of debt. As I have mentioned before Imperial sold its premium tobacco business (including popular brands like Montecristo and Cohíba) to pay off part of its debt. It also cut down its dividend by a third in May 2020 in order to reinforce its focus on cutting down debt (they have promised to keep increasing dividends from this new “rebased” level according to the company’s performance).Fundamentals
Looking at the company’s fundamentals, Imperial Brands is not nearly as efficient as its peers (Philip Morris, Altria, British American Tobacco, and Japanese Tobacco International) at generating operating returns with its capital. Imperial has a ROCE of 17.4%, which is really low compared to Philip Morris and Altria’s 54.6% ad 29%, respectively. Regarding operating margin, Imperial is also behind its peers, as it has an operating margin of 19.4% compared to Altria’s 56.2%, BATS’s 43.2%, Philip Morris’ 42.6%, and JTI’s 22.2%. This could be partly due to Imperial Brand’s inclusion of Logista’s results in its consolidated statements, but it still is not enough to explain the 20%+ difference with some of its peers. With respect to debt and solvency, IMB has a Debt-to-Equity ratio of 252.9%, alarmingly high, although the company has already started its quest to reduce its debt. The financial leverage ratio is also in the higher range of its peers. The interest coverage ratio is only 7.6x, although since debt will be reduced this will come up in the future, but it is still below that of the average S&P 500 company. Regarding liquidity the company has a current and quick ratio of 0.8 and 0.3, a bit low, but could come up with improved profitability and debt reductions.Valuation
To value the company I have made a DCF, although I will also mention some valuation multiples later on. Although I am not a master at doing DCFs, as Seth Klarman mentions in Margin of Safety, what we are looking for is not an exact valuation, but more of a range that we can use for reference. In the DCF I have forecasted a 1.5% sales growth indefinitely, which is in line with management’s estimate of sales growth provided in the 2020 annual report (1% to 2%). Another key input into my analysis was the 7.5% discount rate used (provided by Finbox’s CAPM model). After this I carried out a sensitivity analysis to see how my estimation of value would fair with different inputs into these two key estimates. Here you can view my findings:- 15% WACC & 1.5% Sales Growth: 20.26 fair price, 29% undervalued.- 12% WACC & 1.5% Sales Growth: 26.05 fair price, 67% undervalued.- 10% WACC & 1.5% Sales Growth: 32.19 fair price, 106% undervalued.- 7.5% WACC & 1.5% Sales Growth: 45.6 fair price, 191% undervalued.- 15% WACC & -2% Sales Growth: 18.22 fair price, 16% undervalued.As you can see, my assessment of fair price for Imperial Brand’s stock yields a result of GBP 45.6, 191% higher than the current market price. The worst-case scenario (15% WACC and -2% annual sales growth) yields a fair price of GBP 18.22, which is 16% above the current market price. I believe that, although my DCF analysis could certainly be flawed, we have a wide enough margin of safety (from the 15% WACC, 1.5% sales growth estimate) here to outweigh the potential risks of investing in Imperial Brands. Furthermore, looking at multiples, Imperial’s Free Cash Flow Yield is at 23.2% (12.9% average for its peers), its P/E is at 5.46 (12.97 average for peers), and its EV/EBIT is at 7.78 (9.6 for peers).Conclusion
To summarize, Imperial Brands is not even close to being a high-quality company at the moment, they are far from being the leader in its industry and it just finished a period of mediocre results which could carry on if the current management team doesn’t implement its plans successfully. The argument to invest in this company now would be that of a turn around story at a bargain price. Something to look out for here would be what is going to be the catalyst for the market to close on this price-value discrepancy; in my opinion it could be the spin-off of Logista’s operations or the release of positive quarterly and annual results (reducing debt, improving market shares, and/or improving profitability). Finally, we need to trust the management’s team plan about focusing on its core business and markets and reducing debt.Disclosure
I recently purchased shares of Imperial Brands based on this analysis.
Introduction and Business Overview
Imperial Brands is a Company dedicated mostly to the manufacture, marketing, and sale of tobacco products. The company was founded in 1901, has a current market cap of GBP 14.788 billion, 32,500 employees, and annual sales of GBP 16.6 billion in 2020. According to its market shares it is the fourth largest tobacco company in the world after Philip Morris, British American Tobacco, and Tobacco International (Tobacco Tactics, 2021).
The company has three main lines of business: tobacco, NGP (Next Generation Products), and distribution. The tobacco segment manufactures, markets, and sells cigarettes, rolling tobacco, rolling papers, and premium tobacco (cigars), although Imperial has had to sell the premium tobacco business in 2020 to pay down some of its debt. Some of the most well-known tobacco brands of Imperial Brands are Davidoff, JPS; Gauloises Blondes, West, Winston, and Parker & Simpson. The NGP segment includes products like “heated-not-burnt” tobacco (Pulze), vapes (Blu), and other products like chewing tobacco and snus. The third and final segment is the distribution segment, which is made up of a subsidiary called Logista. Logista is publicly traded in Spain and is dedicated to the distribution of tobacco products, pharmaceutical supplies, and other products in Southern Europe. Logista’s profitability margins are obviously much lower than those of the tobacco business and it contributes arount 7% of the total operating profit of the group, making it a rather small share of Imperial Brand’s business. Finally, Imperial Brands is still a tobacco-centered business, with 87% of the company’s sales coming from its tobacco segment. Around 2% of 2020’s sales came from the NGP segment and the remaining 11% came from Logista.
The company’s core markets around which its current strategy is focused are the USA, Germany, the UK, Australia, and Spain. Tobacco and NGP sales are distributed geographically this way: 45% in Europe, 31% in the Americas (mostly the US), and 24% in Africa, Asia, and Australasia. It is also worth mentioning that the company’s sales are fairly concentrated, as more than 70% of sales come from the aforementioned core markets. Here it is important to highlight the risk that regulation plays in the tobacco industry, as companies are at the mercy of regulators. For example, recently in the US, the sale of flavored liquids for vapes has been banned, which forced Imperial to write-down most of the value of its inventories of this type of product.
Recent Struggles
In the last 5 years the company has not been operating very well compared to its competitors as it has been losing market share in most markets, it has had to write-down several investments due to regulation, and it hasn’t been able to make the NGP business take off. Given these issues, the CEO since May 2010 quit and a new CEO, Stefan Bomhard, was hired in July 2020. Stefan comes from being the CEO and a high-ranking executive of several companies and has lengthy experience in marketing and brand-building and is the first outsider CEO the company has appointed in its 120-year history. The company’s chairwoman has also been a new addition to the team in January 2020, although she had been a member of the board for a few years. With these new two additions the company published in January 2021 its plan to turn around Imperial Brands into the “correct” path. After a careful strategic review Stefan Bomhard decided that the best path moving forward is to focus first in the tobacco segment in the 5 core markets. Despite this focus on the traditional activity of Imperial Brands, the company also plans to keep up investments in the NGP portfolio, although with much more care and thoughtfulness than the previous administration in order to repeat the losses and write-downs seen in the last few years. Finally, it is important to mention that the company is also focused primarily on the reduction of debt. As I have mentioned before Imperial sold its premium tobacco business (including popular brands like Montecristo and Cohíba) to pay off part of its debt. It also cut down its dividend by a third in May 2020 in order to reinforce its focus on cutting down debt (they have promised to keep increasing dividends from this new “rebased” level according to the company’s performance).
Fundamentals
Looking at the company’s fundamentals, Imperial Brands is not nearly as efficient as its peers (Philip Morris, Altria, British American Tobacco, and Japanese Tobacco International) at generating operating returns with its capital. Imperial has a ROCE of 17.4%, which is really low compared to Philip Morris and Altria’s 54.6% ad 29%, respectively. Regarding operating margin, Imperial is also behind its peers, as it has an operating margin of 19.4% compared to Altria’s 56.2%, BATS’s 43.2%, Philip Morris’ 42.6%, and JTI’s 22.2%. This could be partly due to Imperial Brand’s inclusion of Logista’s results in its consolidated statements, but it still is not enough to explain the 20%+ difference with some of its peers. With respect to debt and solvency, IMB has a Debt-to-Equity ratio of 252.9%, alarmingly high, although the company has already started its quest to reduce its debt. The financial leverage ratio is also in the higher range of its peers. The interest coverage ratio is only 7.6x, although since debt will be reduced this will come up in the future, but it is still below that of the average S&P 500 company. Regarding liquidity the company has a current and quick ratio of 0.8 and 0.3, a bit low, but could come up with improved profitability and debt reductions.
Valuation
To value the company I have made a DCF, although I will also mention some valuation multiples later on. Although I am not a master at doing DCFs, as Seth Klarman mentions in Margin of Safety, what we are looking for is not an exact valuation, but more of a range that we can use for reference. In the DCF I have forecasted a 1.5% sales growth indefinitely, which is in line with management’s estimate of sales growth provided in the 2020 annual report (1% to 2%). Another key input into my analysis was the 7.5% discount rate used (provided by Finbox’s CAPM model). After this I carried out a sensitivity analysis to see how my estimation of value would fair with different inputs into these two key estimates. Here you can view my findings:
- 15% WACC & 1.5% Sales Growth: 20.26 fair price, 29% undervalued.
- 12% WACC & 1.5% Sales Growth: 26.05 fair price, 67% undervalued.
- 10% WACC & 1.5% Sales Growth: 32.19 fair price, 106% undervalued.
- 7.5% WACC & 1.5% Sales Growth: 45.6 fair price, 191% undervalued.
- 15% WACC & -2% Sales Growth: 18.22 fair price, 16% undervalued.
As you can see, my assessment of fair price for Imperial Brand’s stock yields a result of GBP 45.6, 191% higher than the current market price. The worst-case scenario (15% WACC and -2% annual sales growth) yields a fair price of GBP 18.22, which is 16% above the current market price. I believe that, although my DCF analysis could certainly be flawed, we have a wide enough margin of safety (from the 15% WACC, 1.5% sales growth estimate) here to outweigh the potential risks of investing in Imperial Brands. Furthermore, looking at multiples, Imperial’s Free Cash Flow Yield is at 23.2% (12.9% average for its peers), its P/E is at 5.46 (12.97 average for peers), and its EV/EBIT is at 7.78 (9.6 for peers).
Conclusion
To summarize, Imperial Brands is not even close to being a high-quality company at the moment, they are far from being the leader in its industry and it just finished a period of mediocre results which could carry on if the current management team doesn’t implement its plans successfully. The argument to invest in this company now would be that of a turn around story at a bargain price. Something to look out for here would be what is going to be the catalyst for the market to close on this price-value discrepancy; in my opinion it could be the spin-off of Logista’s operations or the release of positive quarterly and annual results (reducing debt, improving market shares, and/or improving profitability). Finally, we need to trust the management’s team plan about focusing on its core business and markets and reducing debt.
Disclosure
I recently purchased shares of Imperial Brands based on this analysis.
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