Imperial Tobacco results - rain in Spain (and the US)

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Author:Don Hedley

Date published:27 Apr 2010

Imperial Tobacco reported higher earnings at the interim stage, helped by the strong performance of its global cigarette brands and its fine cut division, but its overall cigarette volumes were down 3.7% and there was evidence of consumer downtrading.

Imperial Tobacco's results over the first half of its 2010 financial year showed a company, like its rivals, delivering value growth despite declining volumes and endeavouring to counter downtrading by pushing its flagship brands into new markets, upgrading and creating variants, as well as developing its non-cigarette businesses. Imperial leads the two main OTP sectors – smoking tobacco and cigars, which gives it a strategic advantage over PMI, BAT and JTI. Its disadvantage is that it does not have the width of geographic reach into the developing markets where the best growth prospects reside.

The company reported 16% growth in adjusted earnings per share, net revenues from tobacco up 4% and adjusted operating profit up 6%. According to the company three quarters of the 3.7% decline in cigarette volumes was due to the steeply falling markets in Spain and the United States and there were also big falls reported in Russia and Ukraine. The company's white stick equivalent decline was 2.1% because of the rise in fine cut tobacco volumes of 9.5%.

Flagship brands – stars of the show

The company particularly highlighted the performance of its flagship brands, with Davidoff volumes up 4%, underlying growth of Gauloises Blondes of 6% (though actual volumes were down 16% due to supply disruption in the Middle East), and volume growth of 8% for the West brand. The company has updated the packs of all three brands and added new formats such as superslims.

According to Imperial, since acquiring the Davidoff brand along with Reemtsma in 2003, volumes have grown 51%. Imperial claimed particularly strong growth for the brand in the Middle East, but also in Eastern and Central Europe and in Taiwan. Gauloises Blondes, Imperial's biggest selling brand, claimed growth in Morocco, Jordan, Lebanon and Syria and has introduced a one milligram tar variant and special edition packs. West is Imperial's second largest brand by volume and the name has been extended into other tobacco products. The brand's recent growth was attributed partly to pack modernisation and partly to the launch of a number of new variants such as superslims and king size superslims.

Fine cut growth

Imperial leads the world smoking tobacco market where it, unlike in cigarettes, achieved strong volume growth of 13% and claimed to have gained an additional two percentage points in market share. Some 90% of Imperial's fine cut volume is in the EU. Fine cut tobacco is a buffer against cigarette volume contraction in some markets: in Germany the company claimed that duty paid cigarette market volumes were down 1% while fine cut tobacco volumes were up by 8%.

Downtrading and legal action in the UK

In the UK the company saw annualised cigarette market volumes as flat with a higher incidence of downtrading following the VAT increase in January 2010. There was also downtrading in Germany and here the company's strategy is to increase share in the value sector of the cigarette market (mid/low price band) by developing the JPS brand franchise - a soft pack JPS variant was launched in November 2009.

In the UK, the company is taking legal action on two fronts. Firstly Imperial is appealing to the Competition Appeal Tribunal against the Office of Fair Trading-imposed fine on Imperial, Gallaher and other retailers for allegedly restricting competition (see article 'UK OFT hits tobacco companies with biggest-ever fine over pricing'). Secondly, the company has just announced that it is challenging the UK government's plans to ban the retail POS display of tobacco products. Imperial announced that it has further invested in anti-illicit trade activities and regards product display bans and plain packaging as helping to fuel the growth of illicit trade.

Spain and US - Imperial underperforms the market

The Spanish cigarette market has been particularly severely hit by the economic downturn, with cigarette volumes falling 11% in the first half according to Imperial and even fine cut tobacco market volumes falling 1%. Imperial stated that its volumes fell more than the overall market due to its leading position in travel retail and the dark tobacco segment. Imperial reported that, due to the Federal Excise Tax increases in April 2009, the US cigarette market lost 11% in volume while its own volumes fell by 18% due to loss of share caused by aggressive discounting and brand repositioning by competitors. Other cigarette markets which impacted on Imperial in the first half were Russia and Ukraine which declined 10% and 9% respectively.

Cigars – fighting consumer downtrading

As a result of the Altadis acquisition, Imperial is global market leader of the cigars sector. In the US cigar market, the world's largest, the federal tax rise contributed to consumer downtrading into lower value and smaller cigars which Imperial attempted to offset by price increases. The company also claimed increased share in the premium segment and continuing strong performance in the mass market natural wrapper category with its leading brand, Dutch Masters. Imperial claimed to be seeing signs of recovery in its Habanos cigar volumes in some key Western European, Asian and Middle Eastern markets, aided by 'positive pricing and better sales mix driving revenue and profit growth'. Imperial is involved in a joint venture with the Cuban luxury cigar maker, Habanos, via its acquisition of Altadis.

Rest of world increases in importance

Imperial is not as geographically spread in terms of sales and profits contribution as its international rivals, so one keenly watched indicator of performance is the contribution from markets outside Europe, the Middle East (where Imperial has a strong leadership position in Morocco), and the US. In the first half of 2010 the company claimed that 23% of tobacco adjusted operating profits were generated by the 'rest of the world' region, compared with 16% in 2007. The company also highlighted three strategic agreements aimed at increasing the reach of its global brands: the manufacture and sale of Davidoff in South Korea by KT&G, the manufacture and sale of Davidoff and West in Mexico with Philip Morris International, and perhaps most interesting, since there has recently been growth in the Chinese cigar market, a framework agreement to establish a collaboration in cigars between China Tobacco Chuanyu Industrial Corporation and Imperial's American cigar business, Altadis USA.

For further insight, please contact Don Hedley, Tobacco Analyst at Euromonitor International, on don.hedley@euromonitor.com

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