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July/August, 2006

U.S. Tobacco Cooperative

Imperial Tobacco Keeps Rolling Ahead

By Joseph Finora

In the first half of its current financial year, Imperial performed well across all regions.

For the first half of 2006 at Imperial Tobacco Group PLC, cigarette volumes hit 86.3 bn, up 9% from 2005. Revenue (less duty) was up 3%, hitting £1,496 mn, while adjusted profit from operations climbed 4%. In a climate rampant with competition, taxation and growing government regulations, what’s not to like about Imperial, the world’s fourth-largest international tobacco company?

“This is another strong set of results,” said Gareth Davis, chief executive. “We increased global volumes of our premium international cigarette brand, Davidoff, and delivered further growth in West and JPS in the Rest of Western Europe. We also achieved a number of other strong regional cigarette brand performances. These successes, coupled with our leading position in other tobacco products, highlight the strength of our broad product portfolio.”

In the first half of its current financial year, Imperial performed well across all regions, increasing its leadership in the UK and also improving cigarette market shares in Germany, the Rest of Western Europe, Africa, the Middle East and Asia.

“Ongoing productivity and efficiency gains continue to support our profit delivery,” continued Davis. “The combination of these operational performances, effective cash management and continued focus on reducing costs, leaves us well placed to build on this positive momentum. Overall anticipated performance of the Group for the financial year remains in line with our expectations.”

Imperial manufactures, markets and sells a comprehensive line-up of cigarettes, tobaccos, rolling papers and cigars, and can bank on sales in more than 130 countries. Its international cigarette brands are the flagship Davidoff, and West, its biggest-selling cigarette brand. The company also has the world’s top two fine cut tobacco brands in Golden Virginia and Drum — products well complemented by Rizla, the world’s number-one rolling paper.

These well-known names are supported by heavy hitters on a regional basis — JPS in Western Europe, Maxim and Mars in Central and Eastern Europe, and Excellence in Africa.

Very often Imperial’s brand portfolio overlaps borders. Such is the case with R1 in Western, Central and Eastern Europe; Boss in Asia, Central Europe and Africa; Peter Stuyvesant in Australia and Western Europe; Bastos in Asia and Western Europe; and Route 66 in Central, Eastern and Western Europe.

Consider also the strength of Lambert & Butler and Richmond in the UK, and Horizon in Australia and New Zealand, and Imperial’s brand portfolio is an impressive one.

There’s a lot to like with Imperial. One of its finest attributes is that it basically keeps things simple. In the manufacturing area, the company acknowledges that it is maintaining its “focus on business simplification, product quality and cost efficiencies.” While this sounds simple and sensible in theory, execution may be anything but these things. So far, however, Imperial has managed to continue delivering productivity gains which indirectly add to the bottom line — sometimes in a big way.

But as with any large company, there are also a lot of challenges. In the first half of the financial year, Imperial’s UK cigarette volumes declined 500 mn to 11.4 bn sticks, although market share is on the increase, thanks to the continued strength of Lambert & Butler and Richmond, and supported by the recent national launch of the Windsor Blue brand. “Almost everywhere it operates, Imperial is gaining market share,” noted Citigroup tobacco industry analyst Adam Spielman. “In the UK these share gains are taking place in a declining market, but the consequent volume declines are being more than offset by price rises and this is likely to continue. In its Rest of the World region, Imperial is growing profits by not only growing the top line but also cutting costs.”

Imperial historically derives a hefty amount of its profits from the UK, which — along with Germany following the 2002 acquisition of Reemtsma — is now one of its two core markets.

The company, manufacturer of nearly 50% of the cigarettes and more than 60% of the fine cut tobacco smoked in Britain, said it is too early to assess the impact on Scottish sales of the ban of smoking in public places enacted in March of this year. Davis described early reports from the hospitality business as a “confused picture,” before adding that “so far we have not seen any effect on our business.” In Ireland, where a ban was introduced in March 2004, tobacco consumption has rebounded after an initial drop he said. Similar bans are expected to hit the rest of the UK in the summer of 2007.

In its competitive trading environment, Imperial will inevitably maintain its focus on cutting costs and generally running a tighter ship. Among other things, it’s been shutting plants across Europe and North America as part of its commitment to improve operational efficiencies.

Imperial’s most recent restructuring announcement came in late July. The company said that it would be closing its factories in Liverpool, in the UK, and Lahr, in Germany by March 2007, resulting in the total loss of 415 jobs.

The vast majority of work at the Liverpool site relates to the packing of Golden Virginia, although the factory’s tradition lies in the manufacture of pipe and snuff tobacco, and it still produces small amounts of these products.

The Golden Virginia packing operations will be transferred to the company’s factories in Nottingham, also in the UK, and Mullingar, Ireland. Contract manufacturing arrangements for the production of pipe and snuff tobacco were being finalised.

Job losses at the Lahr factory had been announced just four months earlier as a result of last year’s European Court of Justice (ECJ) ruling on the taxation of the hugely popular make-your-own ‘Singles’ products in Germany. Imperial, in common with other manufacturers, stopped making Singles on March 31 as it was clear that taxed as cigarettes — and not fine cut tobacco — they would no longer appeal to the price-conscious smoker.

However, in June 2006 the German government informed the industry that the ECJ ruling would also apply to filterless eco cigarillos, which were taxed as cigars. Again, it was clear that these products would no longer continue to appeal to price-conscious consumers, and as a result, the company also ceased production of these products in Lahr on July 31.

The plant had produced around 7 bn Singles and around 900 mn eco cigarillos for the German market in the company’s last financial year. Eco cigarillos (the ‘eco’ stands for ‘economy’) are an American blend tobacco rolled in a brown tobacco paper and come with or without filter. Imperial had hoped that these products would help fill the void left by the loss of Singles — pre-rolled cartridges of tobacco also known as ‘modern make-your-own’ tobacco.

Undaunted, Imperial believes its product range remains broad enough to manage the migration of Singles consumers to alternative products. In March, the company launched West Single Tobacco, a new, high-volume make your own tobacco; the launch of JPS Single Tobacco followed soon after.

Restructuring costs from the Liverpool and Lahr closures are expected to reach about £27 mn this year but then should start saving the company about £7 mn from its 2007-08 fiscal year. These annual savings and costs are additional to those outlined in the original Lahr announcement in March. At that time the company announced annual cost savings of around £4 mn from the 2006-07 financial year and a restructuring charge of around £18 mn.

David Cresswell, Imperial Tobacco Group Manufacturing Director, said: “We operate in a challenging environment and must ensure that we continue to reduce costs and improve productivity and operational efficiencies, in order to further strengthen our competitive position.“

The company’s announcement is in keeping with an industry-wide European trend as tobacco companies have eliminated over 7,000 jobs since the year 2000 as they aim to lower costs. Last year, Imperial also announced plans to shed 200 jobs in Berlin and relocate some cigarette production to Poland to help lower costs. It also completed the closure of a Welsh rolling papers factory in June of this year, transferring production to its Wilrijk plant in Belgium.

Imperial’s recent acquisition activity has been focused in the Scandinavian region. In February of this year, it announced its purchase of Gunnar Stenberg A.S., the Norwegian distributor of tobacco products and accessories. Gunnar Stenberg distributes a range of products in Norway, including rolling papers, cigarettes, fine cut tobacco, snus, and filter tubes. “This further strengthens our competitive position in Scandinavia,” said Davis. As Gunnar Stenberg already distributes Rizla rolling papers in Norway, the strategy behind the acquisition is that it provides a gateway to launch Imperial cigarette brands in the Norwegian market – namely Davidoff, West and, in the value sector, Paramount.

The purchase of Gunnar Stenberg complemented Imperial’s acquisition of a 43% stake in the snus manufacturer Skruf last year. Similarly, that deal provided Imperial with a route to market for West, Davidoff and Paramount in Sweden, as well as adding snus to its portfolio of products. The company has made a commitment to purchase the remainder of the shares in Skruf by mid-2009.

On the executive front, Imperial announced that, as part of a planned succession, its non-executive chairman, Derek Bonham, will retire from the Board by spring 2007. He will be succeeded by Iain Napier, currently joint vice chairman and Imperial’s senior independent director.

Imperial represents what was once a venerable British firm that transformed itself into a global leader. It has an admirable record as a stalwart of British industry and true to its roots, has remained innovative in nearly every area from technology to distribution to anticipating consumer preferences. While it has a very strong stable of brands and healthy cash flow, the tobacco market is now an international one in the truest sense of the word and subject to pressures earlier pioneers never imagined. As Imperial lays its plans, it can hardly do so going it alone. Government pressures, a shrinking consumer base and increased levels of competition have added fierce new dynamics to the marketplace. Imperial it appears however, can weather the storm.

Tobacco International - July/August, 2006

SMOKE Magazine - Cigars, Pipes, and life's other desires

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