Platform for growth

| January 1, 2017

Imperial Brands posts strong results despite declining unit sales—but progress has not been entirely painless.

By George Gay

Alison Cooper

In presenting Imperial Brands’ preliminary results for the year to the end of September, chief executive Alison Cooper said that the company had delivered another strong performance with great results from its expanded U.S. business and had further improved the quality of its growth. “We grew the dividend by 10 percent for the eighth consecutive year and remain committed to this level of increase over the medium term,” she said. “Our strategy is delivering, and we see scope for significant further shareholder value creation by remaining relentlessly focused on the same four strategic priorities.

“We are today [Nov. 8] also announcing further investment behind our strategy to support revenue growth over the medium term. This investment will be supported by a new phase of cost optimization, targeting a further £300 million [$373.5 million] of annual savings by 2020, at a cost of £750 million.

“We have established an excellent platform for sustainable quality growth, which will continue to provide growing returns for shareholders.”

These are the sorts of remarks that are often made by the heads of large tobacco companies—and presumably by the heads of other large companies—when delivering annual results. They make clear that the overwhelming emphasis is on delivering higher dividends for shareholders.

Of course, one thing not mentioned is the fact that Imperial is a tobacco company and that these higher dividends are being predicted even though the company’s tobacco products shipments are in decline. Imperial’s volume shipments of cigarettes and other tobacco products calculated as “stick equivalents” (SE) during the 12 months to the end of September, at 276.5 billion, were down by 3 percent on those of the 12 months to the end of September 2015, 285.1 billion, even though shipments were boosted because the most recent financial year was the first to include full-year figures for its U.S. brand acquisitions. (In June 2015, a subsidiary of Imperial Tobacco, ITG Brands, acquired for about $7.1 billion from subsidiaries of Reynolds American Inc. the KOOL, Salem, Winston and Maverick cigarette brands, along with the Blu e-cigarette brand and other assets.)

The company said that its acquired U.S. cigarette brands had contributed 12 billion SE (compared with 5.4 billion SE in fiscal year 2015 and 17.5 billion SE in fiscal year 2016), or a 4.2 percent increase. However, there had been a 1.5 percent fall during the first half of the year because of the impact of its performance in Iraq and Syria, a 0.9 percent decrease because of a decline in market footprint, and a 4.8 percent drop in the volume across the rest of the business.

Shipments have been slowing for some time. Since 2010, Imperial’s SE shipments have fallen by more than 20 percent, from 348.5 billion to 276.5 billion. But, during the same period, adjusted tobacco net revenue and adjusted operating profit have both increased.

Maintaining revenue

‘Brand migration’ features prominently in Imperial’s strategy

So how can you increase revenue and profits when shipments are going south? Well, one way is to increase product prices either directly, where competition isn’t too fierce, or indirectly through what are known as brand migrations, a strategy at which Imperial has proved successful. For instance, Imperial’s “growth brand” volume during the year to September increased by 4.3 percent, from 145.1 billion SE to 151.3 billion SE, partly because of the company’s brand migration program, which basically encourages consumers to move from brand A to brand B, where brand B is at least as profitable, if not more profitable, than brand A. Such a migration allows, too, brand A to be delisted, which reduces portfolio complexity and, therefore, costs.

This has been an important strategy. As Cooper reported in a results presentation, growth brands continued to outperform the market with volume and share growth. “We further simplified the portfolio through our successful brand migration program so our growth and specialist brands now represent more than 60 percent of net revenues,” she said.

This strategy might seem harsh in respect of the loyal consumers of brand A, but even if it weren’t necessary to try to cut costs, the strategy would probably be inevitable given that regulations in a growing number of countries, such as those requiring standardized packaging and the covering of retail displays, make it more difficult to keep a lot of brand names visible.

And there is evidence that consumers are not overly distraught by the migrations. “We have successfully completed 49 migrations to date, with a further 15 underway,” said Cooper. “These have achieved excellent consumer retention rates, continuing to average more than 95 percent.”

Portfolio management is a major strategy that Imperial will be employing into the future. Cooper said that it was planning to cut radically the number of its SKUs, which can mean delisting whole brand ranges or just some variants within a brand. Imperial did have 250 brands; it is now down to 184 and is aiming to bring that down to 125.

Reducing complexity

Imperial is reducing complexity, too, through its brand chassis strategy, in which it harmonizes brands across different markets, while keeping the individual names of those brands where they contribute to their market success. So, the West chassis, as well as containing West, includes also L&B, Bastos and News. As Cooper said, “Our brand chassis approach enables us to leverage our marketing spend across a range of growth brands.”

Imperial is looking also at its market footprint, at market prioritization, because it generates almost 95 percent of its profit from 32 markets. The U.S. market was large and profitable with high affordability and further pricing opportunities; so a decision had been made to expand the company’s presence in that market last year and to continue investing in the U.S. business, said Cooper. Russia was also a large market where affordability was good and profitability would grow over time.

The footprint strategy meant investing to grow but also investing to defend share where necessary, as in the U.K., which was an attractive market with a large profit pool and where Imperial had strong in-market capabilities. In contrast, Imperial had highlighted markets such as Ukraine and Turkey where a combination of competitor discounting and adverse currency movements had caused the company to reassess its investment plans in the short term. Imperial had not withdrawn from these markets but had decided that investment to grow or defend at this time did not meet its criteria.

But it isn’t all about product and market consolidation. Cooper said that Imperial was building its Blu electronic cigarette brand, which she described as “a very powerful brand in a nascent category,” one that was “well-positioned as a premium offering.” It was encouraging, she said, to see its brand equity building and how well it compared with competitor brands. Imperial had consolidated its presence around its second-generation product, Blu Plus+, “which we believe is the best closed-system vaping experience in the market,” and was investing in its third-generation product, Blu Max, “which we believe will further improve the consumer experience.”

Feeling the heat

Imperial has come in for some criticism because, for the time being at least, it has not extended its vapor product development into the field of heat-not-burn devices, as have Philip Morris International, Japan Tobacco International and British American Tobacco. This criticism, I take it, concerns the fact that these products seem to have met with good consumer acceptance, at least in Japan, as well as the fact that the business model of selling the consumable elements of these devices perhaps better reflects that of selling traditional cigarettes. However, looked at another way, Imperial should be admired for so far refusing to get drawn into offering a type of product that, despite its obvious attractions and benefits, tends to blur the divide between nicotine and tobacco products, much in the way that the U.S. Food and Drug Administration has done and for which it has attracted considerable criticism.

Another way to reduce costs is to introduce efficiencies into your manufacturing processes directly, as well as through reducing portfolio complexity, and Cooper mentioned that Imperial was reviewing its manufacturing capacity and adopting lean operating principles across its factory footprint.

But if such efficiencies aren’t enough, it’s always possible to close factories and reduce your workforce, and, toward the end of last year, several stories started to appear indicating that Imperial intended to do just that in France, Germany, Russia and the U.K. BBC Online reported that up to 100 jobs could go at Imperial’s Bristol, U.K., headquarters in what it described as “structural changes” that were part of its new phase of cost optimization. The BBC story made the point that the announcement about the structural changes followed the closure in May of Imperial Tobacco’s Horizon factory in Nottingham, U.K., with the loss of more than 500 jobs, a closure that bosses at the factory were said previously to have blamed on falling sales and an increase in the illegal tobacco trade.

In addition, a Reuters story reported that Imperial had said it was closing its plant at Yaroslavl, Russia, this month. Imperial was said to have cited “regulatory hurdles such as higher taxes” as being behind the proposed closure, which, according to the story, was expected to result in the loss of 284 jobs.

And then a Le Monde du Tabac story reported that Imperial’s French subsidiary, Seita, had said that it would close its Riom manufacturing facility and its Fleury-les-Aubrais research center, citing a “decline in sales and a resultant drop in production.” The restructuring moves in France were expected to affect a total of 339 jobs.

Asked about whether these stories of closures and job losses were correct, Imperial issued an emailed statement: “We are talking to our employees about a number of proposed restructuring projects as part of our new phase of cost optimization, which we announced in early November,” the statement said.

“These projects include the potential disposal of our factory and research laboratory in France, the closure of a factory in Russia, and structural changes in Bristol head office and Hamburg [Germany]. This will result in the potential loss of several hundred of the 34,000 roles we currently have across our global operations.

“Potential job losses are always extremely regrettable, and we will ensure that anybody affected is treated fairly.

“These are difficult but necessary steps for us to take to strengthen our competitiveness and sustainability.

“Consultations with unions and works councils are ongoing, and we are therefore unable to make any further comment.”

There are at least two ways of looking at this. One is to say that the phrases “extremely regrettable” and “treated fairly” sound rather hollow when people are being put out of work so as to “support revenue growth” that “will continue to provide growing returns for shareholders”—shareholders who, I take it, include at least some of the people making the closure decisions.

On the other hand, Imperial is right in saying that it needs to strengthen its competitiveness, because otherwise it would simply become the target of a takeover by a bigger, more aggressive company that would almost certainly create even more factory closures and job losses when it restructured the acquired Imperial.

The problem here is the system under which the globalized economy operates—a system that rewards companies for closing factories and reducing workforces (and then, in the case of the tobacco industry, whines about these impoverished people downtrading or heading toward the illegal trade for their cigarettes). It is a toxic, failing system that needs to be restructured, if it’s not too late.

 

 

 

 

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