I’m working my way through the annual reports of your favourite FTSE 100 companies, looking for insights into their businesses. Today, it’s the turn of Imperial Tobacco Group (LSE: IMT) (NASDAQOTH: ITYBY.US).
Customer credit risk
Deep within Imperial Tobacco’s annual report (page 121 to be precise) I found an unexpected, and slightly worrying statement: “The Group has some significant concentrations of customer credit risk”.
There are no numbers for us to judge how significant these concentrations of risk are, but clearly the position is less preferable than that of rival British American Tobacco (BAT), whose management tells us: “The Group has no significant concentrations of customer credit risk”.
Geographical diversification
Imperial Tobacco also compares unfavourably with BAT on geographical diversification. In particular, Imperial Tobacco has greater exposure to developed-world markets where volumes are largely stagnating or shrinking. Over half of Imperial Tobacco’s revenue comes from just four countries in Western Europe: UK, Germany, France and Spain. In contrast, BAT’s entire Western Europe exposure amounts to less than a quarter of group revenue.
Business diversification
Imperial Tobacco does have one interesting area of diversification that BAT lacks. This isn’t immediately apparent from the early pages of Imperial Tobacco’s annual report.
Among the five numbers the company chooses to headline are ‘Tobacco Net Revenue’ (£7,007m) and ‘Adjusted Operating Profit’ (£3,180m). Net revenue is calculated after excise duty and similar items. However, when we remove these items from the total revenue in the income statement, there’s still £8,288m unaccounted for. What’s all this about?
Well, Imperial Tobacco has a separate logistics business — in fact, according to the company, “one of the largest logistics businesses in Europe”. This division not only delivers for Imperial Tobacco, but also for other domestic and international tobacco groups. Furthermore, logistics has non-tobacco customers across a range of sectors including telecommunications, transportation, pharmaceutical, publishing and lottery.
The logistics business is lower margin than tobacco, contributing £176m to the £3,180m group operating profit. It shows, though, that the company already has an area of expertise outside of its core business that could be built on to offset a much-expected long, slow decline in tobacco consumption in the coming decades. Who’s to say Imperial Tobacco won’t have evolved into a global logistics giant in 30 year’s time, with a tobacco business on the side? After all, the company had a very different complexion 30 years ago when it was called Imperial Group, with tobacco just one of five business divisions.
Foolish summary
Overall, the things I’ve learned from reading Imperial Tobacco’s annual report suggest to me the company’s not quite as strong as BAT. Arguably, though, that’s compensated for by the relative valuations of the companies: Imperial Tobacco, at 2,219p, is on a forecast price-to-earnings (P/E) ratio of 10.4 and a dividend yield of 5.7%; BAT, at 3,051p, is on a forward P/E of 13.5 and a yield of 4.9%.
