IMBBY - Imperial Brands: Downgrading To Hold Until Reported Results Reflect Strategy Is Working

2023-07-09 02:59:49 ET

Summary

• Imperial Brands is shifting towards its vapor brand, myblu, as cigarette consumption declines, with plans to introduce nicotine pouches to the US market in 2024.
• The company's new approach to expand its Next Generation Products (NGP) share is promising, with the acquisition of US nicotine pouch range L!X seen as a potentially positive move.
• Despite optimism about the company's strategy, I downgrade to hold until reported earnings reflect the positive shift in strategy and regulatory uncertainties are resolved.

Thesis

Imperial Brands ( OTCQX:IMBBY ) is one of the largest international tobacco companies globally. Cigarettes and other tobacco products are manufactured and distributed by the firm under names like Davidoff, Gauloises, JPS, Rizla, West, and Winston, among others. IMBBY is making a strong shift toward its vapor brand, myblu, as cigarette consumption declines in the West. Imperial's subsidiary, Logista, distributes tobacco and non-tobacco products across Europe and also engages in manufacturing.

Although my perspective on the company has brightened since the investor event, I am now downgrading to hold until reported earnings inflect and regulatory uncertainties are gone. I thought the enhanced attention paid by IMBBY customers to operational and strategic delivery was the most notable aspect. I am optimistic about this new GTM strategy since it is being headed by a group of very experienced FMCG veterans who have successfully increased NGP (Next Generation Products) market share. On the point of NGP, IMB expects to introduce moist-style nicotine pouches to the United States market in 2024. If successful, this move might give a significant NGP tailwind to IMB's cigarette business in the United States, where the company has historically faced risk of losing its market share as it does not have a relevant product.

Overall, I think the event has reinforced my belief that the new approach will be successful, boosting IMBBY's capacity to expand its NGP share. However, I don't think it's too late to go long the stock once we see visible results in the earnings report, hence I am recommending a hold.

GTM approach for NGP seems promising

I agree with management's decision to pursue market expansion rather than absolute dominance. The two are very different from one another. In my opinion, the impression of the former strategy suggests that growth will be acquired via sustainable and profitable means, while the latter suggests an all-out strategy –which often times come with burning cash. In light of this, I think it's great that management is putting so much effort towards integrating its challenger strategy to NGPs throughout vapor, heated tobacco, and modern oral. It also reflects well on management as it is naïve to believe this is a winner-takes-all market. Currently, NGP contributes just 7% to Imperial's Europe revenue, but in other regions, such as Italy (41% of sales), Portugal (33% of sales), and Greece (28% of sales), this percentage is much greater. The results from these countries show that the plan put into place has been successful, therefore I anticipate management adoption of a similar approach going forward will yield similar results.

Acquisition of US Nicotine Pouch range

Management recently disclosed that they had purchased several nicotine pouches from TJP Labs in preparation for the company's entry into the current oral market in the United States. L!X pouches are available in 6mg and 9mg doses, in a wide variety of tastes (synthetic nicotine), and under the brand name L!X. The plan of management is to do some more research and then release the product under a new brand name, using the already established sales network in the United States.

Both the bull and bear case for this strategy has merits, and I discuss them below:

The bull argument is that it increases IMB reduced-risk product (RRP) range. This is important for the US market as the US is the largest RRP market globally, and the country's regulatory framework is geared toward hastening the transition to RRP by, among other things, prohibiting menthol cigarettes and lowering nicotine levels in cigarettes to non-addictive levels. Before this purchase, IMBBY has no way to take advantage of this trend (previous vape product attempt received a PMTA denial), as such, it stood to lose the market share that it was commanding. However, this risk is now significantly reduced.

The bear scenario is that L!X does not get approval for its PMTA. Since L!X is a synthetic form of nicotine, it has only been subject to FDA regulation since the middle of 2022, thus the review process is likely to be quite preliminary at this point. Since L!X is a relatively young business, I wonder if the R&D work being done there is adequate to satisfy the stringent requirements set forth by the government. The product has also not been on the market long enough to provide evidence that the flavors would not be overused by young users, which makes the risk even higher.

I am not an expert with the regulations, but from a business perspective, I am encouraged to hear management shifting their previous views that RRP was not an option they want to take (management cited regulatory risk previously).

Valuation remains attractive

IMBBY valuation continues to stay cheap, with multiples seeing further devaluation from 6.3x forward PE to 5.9x forward PE today. When compared to IMBBY own historical valuation, the valuation today shouts cheap as well as it used to trade at 10-14x earnings. If we compare to peers, IMBBY is expected to grow net income by 70% NTM, which is better than peers like Philip Morris (PM) and Altria (MO). While this does not justify IMBBY to trade at similar valuation given these 2 a much bigger players, I believe the discount is too much. My sense is that investors are staying on the side-lines, just like me, awaiting IMBBY to start reporting results that reflect the positive shift in strategy and L!X regulatory uncertainties to go away.

Conclusion

I believe that the new approach will be successful in expanding IMBBY's NGP share, and that the potential reward from a successful rollout of the re-branded L!X’s pouches is high. However, it is advisable to hold the stock until reported earnings reflect the positive shift in strategy and regulatory uncertainties are resolved.

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