Investors in Imperial Brands (LSE:IMB) shares had plenty to cheer in the FTSE 100 tobacco giant’s recent trading update. Highlights included growth in the company’s aggregate market share across its top-five priority markets, a further £1.1bn share buyback programme in FY24, and an expanding alternative nicotine products division. Impressive stuff.
However, Rishi Sunak’s proposal to prohibit anyone aged 14 or younger from ever legally buying cigarettes damages the investment outlook. The Imperial Brands share price dropped on the news, but has recovered in recent days. As traders digest the impact of the government’s new plan, could this potentially be an existential threat to the business model?
Here’s my take.
UK smoking crackdown
No smoking ban has come into effect yet. So far, we have a policy announcement from the Prime Minister. At some point, there will be a free vote in Parliament.
However, New Zealand has already outlawed cigarettes for future generations on a similar basis to the UK plan. In addition, the government’s proposal is likely to attract cross-party support. Potential investors should account for the significant risk of legislation being passed.
The share price impact
A British smoking ban could be critical for Imperial Brands shares. The company generated over 97% of its £3.5bn net revenue from global tobacco sales at the half-year stage.
By contrast, the ‘New Categories’ division of FTSE 100 competitor British American Tobacco, which spans a variety of vapour and oral products, now provides as much of 12% of Imperial’s rival’s total revenue.
Long-term shareholders in Imperial Brands might have good reason to feel anxious about the company’s reliance on traditional cigarette sales amid growing concern combustible tobacco is a sunset industry.
Some will have endured a 34% fall in the share price over the past five years. Sunak’s plan, if it comes to fruition, will be an unwelcome development.
An international business
Yet although the UK is one of Imperial Brands’ priority markets, it only represents 7% of the group’s net revenue. Other key priority markets — Germany and Spain — collectively represent 17%.
That said, there are strong public health incentives for other jurisdictions to follow suit. Imperial Brands’ five core markets are all developed countries — the final two being the US and Australia. There’s a concern if the UK becomes the second country to ban smoking, it won’t be the last.
Risk and reward
Despite an increasingly murky outlook, strong growth in Europe for the company’s Next Generation Products (NGPs) provides a beacon of hope.
Imperial Brands is taking steps to expand this division. The board announced a “step-up in product and market launches during the year” across vape, heated tobacco and oral nicotine products.
It’s encouraging to see the company striving to diversify its revenue sources, but it currently trails the progress of British American Tobacco by a considerable margin.
Further improvement here across all geographies will be essential in my view. But I’m worried by growing speculation there could be further crackdowns on vapes.
For potential investors prepared to take on the risks today, an 8.64% dividend yield and a relatively low price-to-earnings (P/E) ratio around 9 might be tempting. I already own British American Tobacco shares, but I’m reluctant to boost my exposure to the sector at present.
