Imperial Tobacco aims for organic growth

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On the first anniversary last week of Alison Cooper’s appointment as chief executive of Imperial Tobacco, an analyst at Investec Securities reminded investors of the fundamental question that she needs to answer: can the FTSE 100 tobacco company transform itself from the M&A machine it has been over the past two decades into a vehicle for organic growth?

The tobacco marketShareholders may have been temporarily distracted from that question by the announcement that Imperial would begin buying back shares.

The company has paid down debt from its last big deal – the acquisition of Altadis, maker of Gauloises Blondes, in 2008 – to just over two times earnings.

It will also push up dividends, hitting 50 per cent of adjusted earnings this year and aims to increase them ahead of the rate of earnings growth.

But with investors’ “cash return bloodlust now sated” – as the Investec analyst Martin Deboo put it – the organic growth question is nagging again.

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Ms Cooper does not deny the importance of the answer, for employees as much as investors. She recalls how, a year ago, some staff had seemed hesitant about the new direction she was advocating.

She wants to turn a team skilled at bedding down new businesses – from Australian, Dutch and African acquisitions in the late 1990s, to Reemtsma of Germany in 2002 and Altadis six years later – into one that can increase market share and volumes through better sales and marketing.

“They all said, ‘we like Alison, we really want to go for it’,” she says. “But they wanted to get some meat on the bones.” Enthusiasm has grown in the course of the year, she believes, as seen at a recent management meeting in Prague. “All the feedback from Prague was, ‘we really see it’.”

She has also brought in fresh blood. Two recent hires – a marketing director from Reckitt Benckiser and a sales director from Metro Group, the German retail business – underscore her belief that Imperial should think of itself as a regular fast-moving consumer goods company and that organic growth, not M&A, is top of the agenda.

Investors, meanwhile, saw some signs of progress in the company’s half-year results. Sales of its premium Davidoff brand were up 9 per cent, helped by a strong performance in emerging markets. And while the West value brand had subdued growth – up just 1 per cent – and cigarette volumes were down as a whole, fine-cut tobacco volumes rose 5 per cent.

“In most of my discussions with the investment community, I feel there’s a general growing confidence with the organic growth story,” says Ms Cooper.

Mr Deboo is less convinced. He points out that market share declined in the six months to March 31 in 11 of the company’s 20 reported markets, including Russia, France and regulation-hit Spain.

To counter these trends, Ms Cooper has been creating “cocktails” of solutions, designed for each territory. They are based on the notion that Imperial can improve revenues not just through pricing and cigarette sales, but by selling cigars, fine-cut tobacco, rolling papers and filters, even rolling machines.

The difficult UK market, where Imperial generates 13 per cent of its revenues via brands such as Lambert & Butler, Regal and Golden Virginia, is a good example. The company is coping with poorer, recession and austerity-hit smokers by pushing fine-cut tobacco as a cheaper alternative to cigarettes. This year, it introduced an alternative to roll-your-own tobacco: cigarette-making kits, with filters already fitted into tubes, and a special cut of loose tobacco to be fed into the tubes using a machine.

Julian Hardwick of RBS says: “There’s a perception in the market that the European Union is not a good place to have a tobacco business. One of the strong views that Alison has is that there are always growth opportunities. It may not be in cigarettes, it may not be in premium cigarettes, but there are always going to be opportunities, and it’s very important that Imperial capitalises on them through its ‘total tobacco’ portfolio. That’s a key mindset that’s brought to the whole business.”

If Ms Cooper can’t capitalise on these opportunities, M&A could be back on the agenda – this time with Imperial as the target.

Some of the 12 per cent climb in the share price since the start of the year has come on the back of research by analysts at Goldman Sachs arguing that four global tobacco companies – Philip Morris, British American Tobacco, Japan Tobacco and Imperial – is still one too many. They argue that debt across the sector is low, volumes are stagnating and competition issues are not insurmountable, particularly if BAT were to buy Imperial.

Ms Cooper, who occasionally deviates from the on-message, unironic language of top managers to show a more jaundiced view of the world, is sceptical: “Anything to do with four to three has got very significant antitrust issues; I always describe it as not impossible but very difficult. But I’m sure bankers in particular will continue to speculate. Because I’m sure they’d love the fees on a deal like that.”

Her counterpart at BAT, meanwhile, who is also new to the job, says M&A will not be his focus for the next few years at least.

Mr Hardwick, of RBS, argues, like Ms Cooper, that if the market were taking bid speculation seriously, the shares would be much higher than they are. Even Mr Deboo says that the stock is a safe buy, “the closest thing to a bond available in the equity market”. He contests the notion, however, that Imperial is cheap next to rivals with greater emerging markets exposure.

Ms Cooper prefers to see emerging markets as one of the opportunities on offer for a company occupying fourth position in the global market. For the M&A bulls on the sidelines, being fourth could offer other tantalising opportunities, too.

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