And I used to think, how low can a stock go? And for me, Imperial was the test case. But, yes, stocks can go to four times PE is what I learned. Since July 2020, including dividends, Imperial has returned 106%, all numbers till today, and it has outperformed every tobacco stock bar Philip Morris, and also handily outperformed MSCI World Staples Index, which has returned 42% since you joined the company. Now, while this is interesting, what is even more interesting is that Imperial has actually outperformed S&P 500, which is up 92%, and Nasdaq. Now, this surprised me, but Nasdaq is up only 79% since Stefan became the CEO. And, despite all of this, Imperial only trades at 7x P/E.
So, Stefan, the first question is: Can Imperial continue to outperform all the indices as we look out over the next few years?
Yeah, I mean, Gaurav, I mean, firstly, it's exciting to sit here, and with you quoting the facts, as the reflection of the progress we've made. Look, nobody can give you or anybody a guarantee about the future, but I think what for me is exciting is we are today a different company than we were four years ago, and I think the capabilities that we've built from a people perspective, process perspective, clarity about strategy, will serve us well in the future as well, so I can't give you a guarantee where the stock will sit in four years' time, but I think what I feel very good about as we go into the future, we're better placed to perform well in that context.
Sure. And, you know, you launched your strategy now four years ago, the five-year strategy.
Sure.
So since that time, what has surprised you? What... where do you think you are ahead? Where do you think you are behind?
Yeah, I think, number one, what's exciting, and you referred to the share price performance. I think what's exciting is that we're now year four of a five-year strategy. And if you look at it, the circumstances in which these results have been delivered, I mean, most notably the inflation that we all have experienced, are noticeably different versus what we thought it would be like. And we've delivered exactly what we promised four years ago. Now, if you ask me about what a surprise, positively, negatively, I think on a positive surprise side, Gaurav, what I'm truly excited about, it was clear that there were certain capabilities that Imperial did not have, and it needed to have as a consumer goods company.
The ability for us as an organization, with a quite mixed track record, as you said, to attract top talent into the organization. If you look at the executive team today, you can arguably say this is the most consumer goods focused management team of any of the tobacco companies, with virtually everybody having background in consumer goods. I think surprised me. The ability to attract, because normally people say it's hard to attract top talent in the industry, and I think I'm quite happy with the progress. I know it's a positive surprise.
I think the other positive surprise for me was the quality of people I found in Imperial, because of many good people, and the ability of our organization and our people to embrace what has been a very meaningful change, and a clearly very different direction of where we're driving to, was a very positive surprise. So the two combined, I think, has set up well for the change agenda that we have gone through in the last four years. Yeah. If you look at the negative surprises, I have to admit, when we shared our...
At the Capital Markets Day in January 2021, our commitments, what numbers we want to achieve, we couldn't foresee that we would face the single biggest event on price inflation, and that we would have to deal with a war in Europe, which led us to have to leave our Russian business and have significant knock-on effects on many of our European businesses. Logically, the effects of regulation and the lack of enforcement of some of the regulation, I couldn't have foreseen in January 2022. Therefore, from this perspective, I'm really happy that we've delivered what we promised now four years ago, despite some circumstances that clearly were more difficult.
Sure. So, Lukas, you're now in the fourth year of the five-year plan, and the way the guidance was spoken of in 2021, that there will be accelerating growth through this period, it would imply that next year you are looking at 6% EBIT growth. Is that still the expectation?
Let me just go back to the five years plan. As you pointed out properly, the five years plan was always built in two phases. The second phase, in which we are now, was all about accelerating our adjusted operating profit closer to the mid-single digit. And I think if you can see back in 2023, we have accelerated that adjusted operating profit nicely. This year will be another year where we accelerate further the operating profit, so well on track to what we have said to get close to that mid-single digit. And we will come back to you in the market in November to give guidance to the next year.
We are focused on this year to deliver that acceleration, but we are well on track what we have said in our Capital Markets Day of accelerating to a mid-single digit.
Sure. So, now that we are in this fourth year of the five-year plan, should we expect a new three-year or five-year plan sometime in FY 2025? Or would you like to move to an annual guidance kind of framework, given the significant changes which are happening in the industry?
Sure. Number one focus, Lukas touched upon, is about right now, deliver this fiscal year and deliver the final year of our current fiscal year, and that is kind of where priority number one sits. But it's very right to ask what happens after September twenty twenty-five. So in the background, Lukas, myself, the rest of the executive leadership team, and the extended organization is now carving out time to think what comes afterwards. Yeah? At the same time, you will probably understand it's a bit premature to say, is that gonna be another five-year program? Is that going to be another, or is this gonna be more an annual rhythm?
I think what I can give you the confidence on, some of the things that inspired the current five-year program are probably gonna be the same, and I'm talking a bit more about the process. I think one thing I felt very strongly about when we developed the current strat, it starts with the consumer. The consumer decides, because they're the people buying our products every day. And it also starts with the facts. Yeah? Because, if you remember, the discussion was about it isn't what the industry wants, it isn't what some people want. What are the facts? What has been the growth of NGP? What has been the market size development? So these principles, I think it's very fair, they're probably gonna be the same as we develop our program going forward.
Just continuing on the topic of stock prices, so clearly, the U.S. tobacco stocks, they are seeing a lot of interest. They are trading at much higher multiples than U.K.-listed-
Mm-hmm.
non-tobacco stocks. So do you think Imperial can move its listing from the U.K. to U.S., like some other firms in U.K. have done recently in other sectors?
Sure. I think it's very right. If you look at total multiples, the U.S. market has higher multiples than the U.K., no doubt about it. And also, when you look at our industry peers, those listed want to have higher multiples than us. At the same time, I think there are two things I think that are important. The one is the very practical nature. Today, as you will know, one of the requirements is about that the majority of your turnover would be in the U.S., which is not the case for us. U.S. is a very important market, it's our single most important market, as a single country, at around 35%, but it's well below the majority of our business.
And as you will know, it also, one of the big things was that any relisting of a company would require different reportings, but most importantly, it would require for your today's shareholder base to actually approve and support a move to a listing to U.S., which is quite a high hurdle rate, so I think what is right for us and what we have worked very hard, and participating in your conference here is one of the examples, we have been more reaching out to U.S. consumers, to our U.S. investors, making sure that the Imperial story is present with them at events like this, and in one-to-one meetings.
So in principle, the focus of us, our philosophy very clearly is, we're here to create value for our shareholders, and, at this point in time, the focus for us is to deliver the program, and that's the numbers that you shared before. I think we're making good progress, but that is, I think, how we see is priority number one, to create shareholders, value for our shareholders, irrespective where we're listed.
Sure. Lukas, so your key peers in the U.S., Altria and BAT, are barely growing EBIT in the U.S. in FY 2024, and will also be growing U.S. EBIT in FY 2025, which will be likely below what we discussed as your real expectation. So now 6% EBIT growth, you don't talk about, you know, which would be the contributing factor, but assuming it is equally divided across the three segments that you have, you know, neither Altria or BAT's U.S. business will be growing at 6%, that's our estimate. So do you think this creates risk for you long term, in that this can be interpreted as that your key competitors are investing more than you are?
I think we, when you look at that question, you have to probably go back and look at the differences that exist between us and the peers. Imperial has the broadest portfolio. We can reach all consumers at each of the price points, which is a defining feature of Imperial in the U.S. It's a key feature, especially in a market where you also have down trading, which is another feature of the industry in itself. Whereas our peers, their margin pressure comes probably more from the fact that their portfolio is more biased to the premium segment. And so, you know, their margin pressure comes from that on top of the volume pressure that they have. So that's quite different from where we are.
We are well positioned in this market, and so your fears of other people investing more is probably not relevant. We are in the right segments with the right price points and investing behind our brands sufficiently, and I think that's probably the biggest difference.
Sure. So, Stefan, just now, let's talk about the U.S. cigarette market, which is still the largest in terms of profit pool-
Mm-hmm
If not volumes, and the volumes in U.S. cigarette markets have remained pretty weak-
Mm-hmm
On comps, which were already weak. So is minus 9% the new normal in U.S. cigarettes? And if that's the new normal. How confident are you in continued growth in your U.S. tobacco business?
Sure. Now, nobody can give you a definite answer, but I think from my perspective, I don't think the 9% volume decline in the U.S. is the new normal. Because what doesn't change? If you look at the average price of a pack of cigarettes in where U.S. consumers buy it, probably not here in Boston, but more in the South, in the Midwest, it's still one of the more affordable pack prices versus other markets. So the ability to continue to price in this market is absolutely intact. Yeah? I think what we're looking at right now, there are two special effects that increase the market size decline, and they're well covered, and our more U.S.-focused competitors have published quite some information about it, which we agree with. Fundamentally, you have two effects.
Macroeconomically, the U.S. consumer is under pressure, especially the lower income consumer is more under pressure. That means their disposable incomes is more squeezed than before, which we think because as inflation levels are still at elevated levels in the U.S., if this becomes to more normal level, we should see some of that pressure ease, and that should help market size also for combustible cigarettes. Number two, reality is, you are seeing in the last eighteen months, a significant amount of cigarette smokers or dualists who have used vapes use disposable vapes. And fundamentally, because these are all illicit products, as you well know, none of them are approved by the FDA. Nobody knows what's in it because they've not been tested according to U.S. regulations. But per puff, they are significantly cheaper.
Therefore, as consumers economize at this point in time, as long as this offer is illegal in the marketplace, you will have consumers use these products. That is impacting the market. Now, reality is, I'm a big believer that the U.S. government is still one of the best governments in the sense of having clear regulation around a category, and also enforcing it. I can't tell you about what time, how much longer it will take for the U.S. government to enforce these rules that is written in a highly regulated industry, if I may say, more consistently. I have to believe there is gonna be a tailwind from increasingly a more consistent enforcement of the rules that the U.S. government has written to protect its consumers.
Sure. Now, just remaining, still on the U.S. cigarette market, and just as a reminder, the U.S. cigarette business is about 80% of your overall U.S. profits.
Mm-hmm.
So we have had an acquisition recently. Japan Tobacco is entering the market.
Mm-hmm.
They are acquiring Vector Group.
Yeah.
They have said that the combined market share of the two companies will be 8%-
Mm-hmm.
and your market share in U.S. cigarettes is about nine and a half.
Mm-hmm.
And they will also be playing in the discount cigarette segment. So how does that change the competitive landscape for you?
Yeah, I mean, logically, I can't, I can't tell you because I'm not Japan Tobacco. I mean, they will define what strategy they will have once there is approval on the acquisition. What I can tell you is that Japan Tobacco is a very well-known competitor to Imperial. We compete in many markets across a hundred and twenty countries of the world with Japan Tobacco, so it's a very well-known competitor to ourselves. The other thing I would look at it, is the acquisition, the potential acquisition of Vector by Japan Tobacco will give, as you rightly point out, Japan Tobacco, a much bigger presence in what is the deep discount segment. That is where one third of our business sits. Two-thirds of our business sit, does not compete against that. That's an important distinction, and I think, therefore, we feel, we...
Today's assessment of us, I don't think it will dramatically change the dynamics of the marketplace. And there are probably two important points I would add. Because of the unique regulatory nature of the U.S., that you cannot launch new brands into the U.S. market, that does mean that Japan Tobacco will compete only in one segment. Yeah? And finally, I wanted to build the bridge back to one of the other questions. I think one thing not well understood and not well talked about, I think we need to look at in the perspective, this is a company that has a very long-term point of view, and they've just placed... This is the single biggest acquisition they would have done in many, many years.
The way we look at it, they've just put a big investment into the U.S. market, what I would see as a signal of confidence that the U.S. combustible market will continue to be a very attractive market for many years to come. Otherwise, you wouldn't have invested shareholders' money into the U.S. market.
Sure. Lukas, you know, a couple of questions for you because some of your peers have commented on these topics. So one is, and this is focused on the U.S. cigarette market, that there is the end of the MSA legal settlement bill, which happens in December 2024, and it is, that amount total is at $500 million capped for the industry, and everybody has some share in it, and Altria has disclosures on this in their 10-K. So the question is, how much did you pay in FY 2024, and then will that go away for you also in FY 2025, and how much is the benefit from that?
So as a smaller player, we actually never had to pay any MSA legal settlement bills. So the legal bills we pay obviously the fees, but not the legal bills, so there is no change for us going forward.
Okay. And secondly, also on the tobacco leaf costs, which were inflationary for the industry over the last couple of years, and then we have had one of your peers say that tobacco leaf costs have peaked, and they might be deflationary in 2H of this year, calendar year, their calendar year. And then in FY 2025, it might completely unwind the tobacco leaf inflation. So how are you thinking about your tobacco leaf costs?
Yeah, again, for us, the good thing on leaf is given our margins, you know, our COGS is only 30% of our revenue. Leaf is only 30% of that 30%. So you know, it, you have to see that proportion of the cost first. The other thing is, like most of us, we buy the leaves a year in advance, so we have very good visibility of what costs will do. There is a lagging effect. That's why we also have quite a significant inflation this year, still on leaf, so it's roughly 14-15% that will hit our P&L this year. And indeed, we do see that coming down. Some of that inflation is also driven by the U.S. dollar currency fluctuation. But as I said, we see that inflation coming down.
In our case, given also that the U.S. dollar, given also some of the events we have seen in one of the largest tobacco leaf markets, which is Brazil, I would... You know, there's a difference between coming down and being a deflation. We don't see that. We still will have inflation next year, but less than we have this year, for sure.
Sure. Now, talking about the other 20% of the U.S. business-
Mm-hmm
which is cigars. So it had done pretty well during COVID in the last two years. There has been a massive unwind. So can you just tell us where we are with your cigar business? And, you know, one of your key competitors, they have made comments that they are looking at a strategic review of the business-
Sure.
That's Philip Morris.
Mm-hmm.
How do you see, you know, the evolution of the U.S. cigar market?
Sure. Gaurav, I think overall, what is exciting right now is you now see the mass market cigar market, the market returning again to more normal circumstances. In the run-up to COVID, you saw some very significant market size growth of that market, which then exploded even more in COVID as consumers had very few opportunities to spend their money. And then in the last two years, we saw a abrupt decline of the market as consumers spent their money again on other categories, including the hospitality industry. And at the same time, as you asked Lukas about leaf inflation, mass market cigars, the cost of goods, of leaf is significantly higher than in cigarettes. And there we saw, because you're looking at some very premium leaves, you saw even more of inflation.
So the industry had to take some hefty pricing to reflect the increased costs of goods there. So you had the double whammy of consumers kind of coming out of the category because they had - they were spending their money in other categories again, and on top, us increasing prices of the industry to pass on the cost of goods inflation. What I think is exciting to see and reassuring, I think, for us, if you look at the last twelve months now, you see the industry returning to a much more normal pattern. You still see some volume declines, to be clear, but that's normal. I think some of the big growth of the mass market cigar sector is probably over. But I still... What you can still see, a significantly more attractive market size development versus combustible cigarettes.
Why is that exciting for us at Imperial? Because our market share in mass market cigars is well above our market share in cigarettes. On top, we own the most desirable and the most premium brand in the entire sector with Backwoods. This year specifically, if you look at our market share development, also helped by great innovation that we have in the marketplace, we're gaining. Despite this being quite an expensive product, a very premium product, in a world where consumers are counting their pennies, we're seeing the Backwoods brand gaining share. I feel very good about this being in this segment. I think it's an exciting segment. It's gonna be one that will be a growth driver for Imperial for many years to come, and we have a great brand portfolio there.
Sure. So now, moving to Europe-
Mm-hmm.
So, now, and Lukas, maybe, you know, a question for you, that we are seeing very strong growth in European volumes this year, which is on top of strong volumes, which happened last year and which were very strong the year before that. So what do you think is driving this exceptional growth in the European cigarette market?
It's a very good point, and, you know, we focus a lot on the U.S., and the U.S. has a very specific connotation. But after the volatility of COVID, what we are seeing actually at group level is volumes declining, again, much more in line with a long-term trend. And that is true also in Europe, and that's good. I mean, that's really what you see the norm, and the U.S. is the outlier, et cetera. And you see also from our big markets, like Germany and Spain, that volumes have recovered really well. The reason behind that is often that in those markets, the affordability of cigarettes is still very good, especially compared to NGP. There is no big differentiation in pricing to NGP, hence, there is not much of an incentive.
The other part is probably what we call stigmatization of smoking. You know, in Spain and Germany, you still have a lot of freedom to smoke, hence, the predominance of NGP is less, the penetration is much less, hence, your volumes in cigarettes are maintained very well.
Sure. So, Stefan, you know, when you had arrived, then, you know, there was, you know, Imperial used to lose market share-
Mm-hmm.
Consistently into a number of countries, and one of the key targets was to improve market share performance.
Mm-hmm.
It has turned around in most countries, almost all the key markets.
Mm-hmm.
except for Germany.
Yeah.
But even there, the trend of market share losses has improved, so you're losing less share-
Yeah
-than, what used to be the case. So can you just help us understand what's happening in the German market, and-
Yeah
Why has it been so hard to turn that around?
Sure. Absolutely. I mean, Gaurav, first you touched upon it. I think what's very important, if you look at our strategies that we've been delivering against, on day one, when we launched in January twenty twenty, we said we want the aggregate market share of these five markets together, weighted by their respective size, to be flat. We didn't want to be the number one share donor in these top five markets combined that we had been before. And every single year since we launched the strategy, we've held our share or gained share. So right now we're, if you look at the whole period, of up forty basis points, yeah?
But I think we made it clear that that doesn't mean we're going to gain share in all five every year, because this is a highly competitive industry, and our top five includes some of the most competitive markets like U.S. or Germany, or markets like U.K. and Spain. And therefore, and it, it's funny because I don't know who asked the question. Might have been you, Gaurav. I mean, I was asked when we launched the Capital Markets Day in January 2020, saying, "Stefan, which market do you think is going to take the longest to turn around?" When in reality, all five had lost market share. And I said then, Germany, because from the knowledge and the data we had, it, a, had been the one where we had lost market share for the longest period of time.
One factor that's probably not that well understood. It's a market where your A&P spending is still quite high because you have less restrictions. You can still provide... You can still do a lot of brand building towards adult smokers, and we had invested for quite a number of years. Our competitors, given how attractive the market is, had continued to invest. To turn around what has been a decade of underinvestment, we knew would take longer, and it's taking longer. The great news, as you touched upon, what is exciting now is this fiscal year, when every year before we had lost 70, 80 basis points. At the half year we lost around 25 basis points. Still losing share, let's be very clear, but materially less than in the prior years. This year we can really see the green shoots.
And it's the same playbook that we've used in the other market, but we knew this playbook would take longer. So I'm excited. I can't tell you when the German market will report a green number, but I have to believe at one point in time it will also report a green number. But then I immediately will tell you, therefore, another market in the top five will struggle. But I think what's important from an investor perspective, you get the sense Imperial just manages as a portfolio, and the underlying assumption that we're not going to shed share to our competitors in our top five markets is the underlying principle.
Sure. And now, quickly turning to NGPs.
Mm-hmm.
So you are present in all the NGP categories?
Yeah.
Tobacco, e-cigarettes, as well as modern oral. So do you think you are at a point where prioritizing one or two of those categories would make more sense, given the strong growth we are seeing, you know, especially in modern oral?
Sure. And let me take you back, Gaurav. Reality is, when we started this strategy, it's pretty fair to say we weren't terribly successful, and the big category we had invested in was vaping. At one point in time, that was the only category Imperial was present in. And when we worked on the strategy, and we did a lot, I mean, I looked a lot of the data with the team, and it became very clear that consumers, depending on the market, have made different choices. If you go to the Nordic countries, it's all about oral nicotine, modern oral nicotine. You go to a market like Italy, it's all heated tobacco as a primary preferred category. But then you travel to France, yeah, and just one across the border, and it's all a vaping category. So I think...
And also what I observed, and four years later, it's even clearer: consumer preferences can switch very quickly, yeah? But the reality is, we fundamentally believe if we want to serve our consumers where there's a sizable NGP market, given where the market is today, you have to be in all three. So I think what's exciting: we have that capability now. We have offers that are competing well in the marketplace, despite our smaller scale, in all three categories. So wherever the market switches, we have that agility to operate in. So I wouldn't want to prioritize today one, because this is a lesson learned from the last five to ten years of development of NGP. It's still a very dynamic field, and it's about the ability to be present in all three categories.
Unless there's a clear picture emerging what consumers prefer across the portfolio of markets, I think having competitive offers in all three categories is one of the recipes of success for Imperial.
Sure. So Lukas, now turning to capital returns, which has been a very exciting part of the Imperial narrative over the last few years. So, you know, two years ago, you did £1 billion share repurchase last year, or this year you're doing £1.1 billion, and the obvious question becomes: where does it head to next? So can you just help us, or remind us what's your philosophy on buybacks versus dividends, and how we should expect the growth in them?
Yes, very pleased to do, though. I think as I mentioned in the past already, for us, the capital allocation policy is a key value driver. It goes hand in hand with our strategy. Our strategy will deliver the cash we need, and this is fundamental. Without cash, there's no point in having a capital allocation. Having cash or a good strategy without capital allocation doesn't work either. So capital allocation remains fundamental for us. And, you know, after having invested sufficiently in our business, maintaining our strong balance sheet with our leverage where it is right now, it then comes to the point, as you pointed out, Gaurav, in terms of how do we balance properly a progressive dividend policy based probably on the underlying performance in terms of adjusted operating profit with the share buyback? And we are an and company.
We want to do both, and we have the resources to do both. And I think what you have seen in the past is that we have continued to do a progressive dividend policy, and we have meaningfully increased the share buyback over the last two years. And I think that's really important. For us, the share buyback is a fundamental part of the capital allocation. We have been very clear that it is a multi-year share buyback program. Our cash flow gives you confidence that we can sustain that. What the exact value will be will always be defined at the end of the year when we discuss that with the board and come to the market to define exactly the value.
But what I want you to be confident about is that there is a multi-year share buyback, and the share buyback has always been meaningful. I mean, every year, the last two years, we have retired more than 5% of our share capital. So that should give you confidence also going forward into the next year.
Now, if you know your leverage target is 2x, and EBITDA is growing mid-single digit, and next year the expectation, let's say, is mid-single digit, then your leverage will keep coming down if you're returning only 100% of free cash flow to shareholders. So is there an opportunity to return more than 100% of free cash flow to shareholders?
Again, you know, probably the problem you are describing is a nice problem to have for a CFO, I have to tell you, and I think what we are trying to do is be very consistent. What you have seen is we decide every year what is the best way to serve the shareholders in terms of excess cash returns. You're right that over the next two, three years, not necessarily in the short term, if everything goes as planned, there will be more opportunities for that, but right now we're focusing on this year and next year, and we will always be very reasonable in those share buybacks. It's gonna be meaningful, but we're also maintaining some headroom for us to be sure that we weather all the unexpected events. So that's where we're heading.
When we come to that point, we'll have that discussion.
Sure. And we are almost out of time here, but we have a breakout session in the next room as well. Thank you so much, Lukas. Thank you so much, Stefan, for giving us the opportunity.
Thank you very much, Gaurav.
Thank you, Gaurav.
Thank you.
Thank you.