Deadly Tobacco: Why did Alex Wright cut Imperial Brands?

Gavin Lumsden quizzes Fidelity Special Values' Alex Wright on why the maker of Gitanes and Winston cigarettes is no longer in his top 10 holdings.

Citywire’s Gavin Lumsden (pictured) quizzes Fidelity Special Values’ (FSV ) Alex Wright on why Imperial Brands (IMB), the financially strong and high-yielding maker of Gitanes and Winston cigarettes is no longer in his top 10 holdings.

This is the fourth and last excerpt from our virtual event with Wright last week. You can watch our previous short videos in which the fund manager:

If any of those whet your appetite, you can also watch the one-hour ‘Big Broadcast’ of the whole event in which Wright talks about the opportunities in a UK stock market that is one of the cheapest in the world, and answers investors’ questions.

Can’t watch now? Read the transcript

Gavin Lumsden:

What’s your view on tobacco stocks because they’re often challenged on the health impact they have on smokers. Imperial Brands (IMB) was a 3.7% top ten position last November, but it’s not in your top ten now. Is that because you’re less defensive now or do you have doubts about the company’s ability to move into next generation smokeless products, for example? 

Alex Wright:

Again, it’s another interesting area because again, both the tobacco companies score very well on external ESG ratings because they have very good disclosure and they have very good employment policies and they have a very low footprint in terms of costs to produce because the margins of the companies are so high. Obviously, on an absolute basis, you’ve got to stand back and say, obviously, this is a product that ultimately, does kill people. So, it’s not a good product and therefore, obviously, there’s going to be continued taxation of the product and a desire for volumes to fall over time and indeed, that is what these companies are doing. So, I do think the glidepath is positive because clearly, these companies that are seeing volumes decline annually 4% to 5%, putting up prices 6% to 7%, encouraging people to give up smoking, but at the same time, making more profit out of those that continue to do so and then obviously, the companies are also looking to move their existing consumers to reduced harm products. 

Hopefully, within my lifetime, we’ll see certainly in mature markets this product, go away, but they can make a lot of money in the meantime and if they really can transition their products, we can see a much higher rating and also because the taxation is quite different, potentially, a higher profit as well. So that’s an interesting industry thesis.  

Imperial is then the cheapest of all the companies. So, it’s on about six times earnings with a 9% dividend yield. Also, with a strong balance sheet, much stronger than BAT (BATS) [British American Tobacco]. So that’s why we’re invested here. Strongest balance sheet, lowest valuation. The big issue is that I think, while the transition to next generation products, it’s still unknown exactly what people are going to want to use in terms of vaping versus heat not burn, modern oral,  there’s a lot of different products could use, my thoughts were that this company has time to transition and again, as a fast follower business, the CEO comes from previous time at Bacardi, that really wasn’t an industry leader, very much a fast follower in spirits, you can really copy anything that works. The reason I’ve cut back the position is that it does look like the IQOS product from Philip Morris is taking off in Europe, more quickly than I thought it would 12 months ago and that is a risk because Imperial are only, today, just developing their heat-not-burn product, only testing in two markets. They have a good vaping product, but it looks actually, like heat-not-burn is the product that consumers are currently preferring and Imperial are a laggard there. So, I think it’s still very much an exciting potential, but the risk is higher than I thought it was because if Philip Morris really get an entrenched position in Imperial’s big tobacco markets, that will be negative for the profit in those markets, quicker than I thought it would be. So, we need to manage the position size and we’ve cut back to about a 2% position size today, despite the fact we’ve still got a strong valuation support from the dividend and the strong balance sheet. 

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