Imperial marks just need to last a few more rounds (OTCMKTS: IMBBY)

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Posted on the Value Lab 4/18/22

We all know what we buy with Imperial Brands (OTCQX:IMBBY), and it’s a company screwed on demographics, regulation and product innovation. Its main competitors, British American Tobacco (BTI) and Philippe Morris (PM) have extraordinarily limited the demographic and product innovation issue with PM’s IQOS and BTI’s Glo in the area of ​​non-combustion heat, with BTI also benefiting other alternative vaping and tobacco products. They deserve to be valued much more. Yet Imperial Brands is so cheap that investors should think twice, and we believe there is enough value at current prices and in the current environment to consider a limited investment position. Macroeconomic as well as geopolitical factors are working in IMB’s favor, and they only need to last a few rounds longer than the bookmakers expect us to make money. We believe that on this second wind they have not been sufficiently priced in and offer a lot of value for investors who question the direction of the market and worry about the economy over the next 12 months.

Forces

Rising tariffs and inflation

The big thing we’ve been thinking about is what’s going to happen when central banks raise rates. The main question we have is how the markets will react if inflation remains high. We believe that will be the case, and that is why banks are going to have to raise their rates a lot before inflation really subsides, because it is a question of supply. Our internal view is that interest rates reach 6% based on the calculations we show on the Value Lab regarding the shift in demand for goods-services and the money supply. This would be concomitant with still relevant levels of inflation. Overall disposable incomes are going to be impacted and all critical market forces point to fundamental market issues as the pandemic is still an issue.

Since disposable income could be affected in a rather malignant way, as is the case with productivity issues, the most defensive thing is tobacco.

Ukrainian invasion

The reason we chose Imperial Brands has to do with the second force, which sets them apart, and that is the invasion of Ukraine. Here are the reasons why IMB is preferred given this development.

  1. IMB has minimal exposure to Russia, while comparatively BTI and PM not only have substantial exposure to Russia, but it is biased towards their more profitable products like IQOS and Glo. So there is a volume and mixing effect that will hurt both of them and not Imperial Brands at all.
  2. IMB offers many products at reduced prices, particularly in the United States (30% of net sales). With rolling tobacco and other cheaper brands, it will work well in a falling price environment. The current environment could really involve a lot of downtrading due to the rate and inflation factors mentioned above, but also because their competitors will have to use prices to recoup lost profits. Competitors raising prices are good for IMB and give them room to weather the economic heat.

SA commentators have mentioned indirect forces that can work against the IMB. A very interesting effect has been the redirection of next-gen product volumes from Russia to residual markets, resulting in more IMB customers being donated to the top performers and their new platforms. With IQOS and Glo powerfully converting traditional smokers, and with IMB not being present in new products, this has been a problem for IMB for some time. The question is whether these forces will accelerate under the effect of Russia, which would be a reason to ignore this stock. We went ahead and spoke to marketing industry insiders to verify this risk. We found that the current situation is unlikely to lead to acceleration, as the push has already taken place at the best crossroads of pace and efficiency, and pricing of traditional products is a bigger concern at this time. . Additionally, it will more quickly dump traditional users onto cheaper and less taxed platforms like HTP that they also own rather than always onto competing brands. Still, there will be more room for IMB, which only exists in traditional products, as the big players are a little more crippled by earnings growth issues in light of Russia.

conclusion

Imperial Brands has major structural issues. It is a major incumbent in markets that experience the most pressure from governments, such as Australia, but lacks sufficient presence in markets with better demographics and regulatory regimes . Moreover, its demographic situation is all the more difficult since the new generation of products, of which it does not have to boast (at least none with a significant presence on the market), appeals more to young people than to old people. When these products mainly cannibalize in traditional markets, IMB loses twice. It’s not a company with great prospects, but it trades at 7x EV/EBITDA, 70% of PM and BTI’s valuation. Fair enough to be honest, but the fact is that any situation that heals some of their incurable wounds and keeps them alive presents opportunities for investors because expectations are so exceptionally low. With inflation, the price environment is favorable to them, with economic decline, tobacco is still robust. With the situation in Russia, they are doing relatively well, even if they only stick their heads above water for a moment before continuing to sink.

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