IMBBY - Imperial Brands: Recommend To Size Position Small

2023-04-18 17:39:46 ET

Summary

• Imperial Brands PLC's 1H23 trading updates were in line with previous guidance, and there was no change to FY23 expectations.
• The new EU Tobacco Tax Directive and a comprehensive new UK Tobacco Control Plan both carry potential media attention.
• Imperial Brands is trading at a relatively low valuation compared to its history, and if it returns to historical growth and margin levels, valuation may move up.

Thesis

Imperial Brands PLC (IMBBF, IMBBY ) ("IMB") ranks among the world's largest publicly traded tobacco companies. Cigarettes and other tobacco products are manufactured and distributed by the firm under names like Davidoff, Gauloises, JPS, Rizla, West, and Winston, among others. Cigarette use is on the decline in the West, so Imperial is focusing heavily on its vapor brand, myblu. Although Imperial is best known for its manufacturing operations, the company's European subsidiary, Logista, is a sizable distributor of both tobacco and non-tobacco products.

I don't think there were any big surprises in IMBBY's 1H23 pre-close trading updates a few days ago. The 1H23 performance was in line with previous guidance, and there was no change to FY23 expectations. The top line is anticipated to be relatively stable compared to the same period last year, with an uptick anticipated for the second half of FY23.

My gut tells me that IMB's performance from last year, when it posted 0.3% organic sales in 1H22 and 3.8% in 2H22, will be repeated in 2H23. Given the challenges posed by higher NGP investments, the pandemic unwind, and the Russia exit, I view the expectation of a flattish 1H23 EBIT as a success. Additionally encouraging is the anticipated increase in NGP sales for 1H23.

Elsewhere, the fluctuation in FX may also have some effect on top-line numbers, possibly exerting a slight downward pressure on consensus EPS. In my analysis, the reaffirmation of guidance is likely to alleviate investor apprehensions regarding the potential influence of the U.S. market downturn on FY23 guidance. But I would warn investors that with all the regulation risk, the risk and level of uncertainty today is much higher than last year. If I were to invest, I would start off with a tiny stake in order to take advantage of the low valuation in comparison to history.

Highlights from 1H23 update

The anticipated decrease in sales volume due to the unwinding of COVID-19 benefits will balance out the strong pricing of combustible products. This is expected to result in a net revenue ex-FX level similar to last year, excluding the impact from Russia. However, if the impact of leaving Russia is taken into account, net revenue ex-FX is expected to fall slightly below last year's levels. Additionally, investments in NGP, leaving Russia, and the gradual decline of COVID-19 benefits are anticipated to affect the tobacco and NGP sectors, but growth in Distribution will partially offset this impact. As a result, the adjusted operating profit ex-FX is predicted to be comparable to the same period last year.

Management anticipates that the total market share of IMBBY's top-five priority combustibles markets in the first half of the year will remain similar to the previous period. The U.S., Spain, and Australia are expected to exhibit growth or stability in market share, while decreases in market share in Germany and the UK will be offset. Additionally, NGP 1H23 revenues are expected to increase year-over-year, fueled by an increase in product and market launches. Despite a decline in the U.S., strong growth in Europe will more than make up for it.

Guidance

It is comforting to note that management has stated that they are on target to achieve their FY23 objectives, which include a low-single-digit % ex-FX sales growth and implied mid-single-digit constant currency EBIT growth at the lower end. My take is that the second half of the year will be more critical due to the timing of NGP investments and the effects of the Russian disposal. Net debt to EBITDA is projected to stay near the bottom of the 2.0-2.5x range for the full year FY23, with FX providing a tailwind of 2.5-3.5% to EPS. Mid-term guidance is also reiterated for FY23-25 constant currency EBIT CAGR of mid-single digits, which I believe should also better help consensus better model future earnings growth.

What could go wrong

Despite the reassurance provided above, I would recommend pausing to consider alternative interpretations of this print. Even though full-year guidance has been maintained, I'm worried that IMBBY won't be able to deliver as promised, especially in terms of revenue. To be specific, the likelihood of IMBBY achieving its targets is heavily dependent on the second half of 2023. This is a cause for concern, particularly because sales in the first half of the year have decreased, and there has been no improvement in market share trends after some progress.

Additionally, there are concerns about NGP trends in the U.S., and the guidance for tobacco and NGP trends for the entire year is down. With UK volumes possibly being affected by the recent tax increases , I'd like to remind investors of this fact. Concerning the United Kingdom, it is not known when a government program offering free vape to smokers will be launched. Finally, the new EU Tobacco Tax Directive and a comprehensive new UK Tobacco Control Plan both carry the potential for significant media attention. Investing today carries a much higher degree of risk than it did a year ago because of the greater degree of uncertainty.

Valuation is relatively attractive

A plus for IMBBY is that it is trading at a relatively low valuation in comparison to its history. IMBBY is currently trading at 6.3x forward P/E, which is nearly 4x lower than its historical average. If IMBBY is able to return to historical growth and margin levels, it is not unreasonable to believe that valuation will move closer to the historical average. Furthermore, as EBITDA grows, the leverage ratio should continue to fall, implying that IMBBY will be able to use its balance sheet to buy back shares.

Conclusion

IMBBY 1H23 trading update was in line with previous guidance, and management has reiterated its full-year guidance. Despite challenges posed by higher NGP investments, the pandemic unwind, and the Russia exit, the reiteration of guidance should help to calm investor concerns about the impact of U.S. market weakness on IMB's FY23 projections. However, there is a risk and level of uncertainty today that is much higher than last year due to the greater degree of regulation risk.

While Imperial Brands PLC's valuation is relatively low compared to its history, investors should still exercise caution and start off with a small stake if investing in the company. Overall, the second half of the year will be more critical due to the timing of NGP investments and the effects of the Russian disposal, which could impact Imperial Brands PLC's ability to deliver on its promises.

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