Imperial Brands: An Ode to Zero

“Logic is the technique by which we add conviction to truth.” - Jean de La Bruyère

Shares of Imperial Brands are down 8% following the release of its April Trading Update, and down 13.5% since my last note on the company. By now, you know I have little interest in short-term market price movements. But this case is interesting. Is this movement expressing fear? Doubt? I have re-read the release several times, assuming I must have missed some very fine print that clearly states that things are going poorly. I have yet to find such a statement. In fact, business appears rather ho-hum, with the company continuing to execute exactly as it said it would.

There is chatter about NGP losses. The company rightly remains guarded as it scales. Then there seems to be some discussion about the group signaling a loss of aggregate market share in its top markets this year, as if that were a foreboding sign. Chasing market share is dangerous. Imperial Brands continues to explicitly talk of balancing share and price. Many investors seem to want the former, without admitting that the latter plays a meaningful role in driving larger and larger cash flows. And in that vein, the company continues to deliver. Roughly half of the FY’26 £1.45 billion repurchase program has been deployed. Once this program dries, another will be put in its place.

“But wait!” they say. “This can’t go on and on!” We have heard the arguments time and time again. Imperial has not innovated. It is not a leader in NGPs. It is not the largest. Surely, any minute now, the descent toward oblivion must begin.

The point has been made before that one must consider the anticipated decline rate of the business they expect against the rate at which equity is retired through share repurchases. I maintain my view that the latter will keep winning that race. Such a view remains in the minority but is further supported by the fact that the company’s H1’26 trading update has upheld FY’26 guidance.

It is with that consideration that a continued, sizable repurchase program, paired not with a shrinking business but with a modestly growing one, rests. There is a simple formula for growing earnings-per-share at a high clip, alongside a 6% forward dividend yield and an easily met payout ratio, at multiples below the industry’s, which itself is far below the market’s. I may tire of saying it one day, but not today: any further selloff in share price must be cheered, as it will positively support the rate of repurchase.

Given the short length of the trading update and the lack of any real surprises, stopping there would be adequate. Instead, let us take a different route to drive these points home. We must start by striking a somber note.

Everything goes to zero. Eventually.

By now, you have likely heard of the death of the venerable Murray Stahl. As co-founder, Chairman, and CEO of Horizon Kinetics, Stahl exhibited curiosity, creativity, and conviction to the extreme. He was a lifelong student of history and had built a massive breadth of knowledge. His writings often pulled inspiration from the seemingly unrelated, inevitably connecting the dots in his own unique way, with a level of clarity practically unmatched. I have no doubt that his writings will continue to teach and aid countless. They will certainly continue to inspire me.

Amongst the well-known writings of Horizon Kinetics is the Contrarian Research Report on Texas Pacific Land Trust, dated May 8, 1995, “How to Buy 1 Million Acres of Fine Texas Grazing Land for $20.00.” It is clear, concise, and perfectly demonstrates elite ability in the most compelling way. Since that write-up, TPL shareholders have recognized remarkable returns.

What does this have to do with Imperial Brands? Nothing, and everything.

The contrasts are numerous. In 1995, TPL had zero debt and a fixed dividend that equated to a yield of 2% and a payout ratio of 40%. Presently, Imperial Brands is less levered than its industry peers, but still has net debt roughly x2 its EBITDA. Imperial’s forward yield is currently 6%, equating to a payout ratio of 50%, and is aimed to grow by roughly 4.5% each year. These different metrics are eclipsed by the contrast in the nature of these businesses.

TPL, as a going concern, is inextricably linked to land in West Texas. Conversely, Imperial’s value is largely tied to intangibles associated with its product portfolio. There is no asset with a greater duration profile than land. While not necessarily as durable, brands can take up considerable real estate in consumers’ minds, with such plots even being passed down through generations.

In both cases, these are extremely defensive businesses. The nature of the TPL’s business makes it an unmistakable beneficiary of inflation. Imperial has tremendous pricing power, underpinned by inelastic demand for its products. Both of these concerns are relatively predictable and carry lofty margins, far higher than those of the average business. Each is also supported by a mix of barriers, such as regulation, physical proximity, and the like. Compared to so many other flashy companies, both of these are also straightforward businesses.

In its early years, TPL’s revenues were primarily from grazing lease rentals and modest land sales, followed by oil and gas royalties and related matters. Though composition and nominal amounts changed, the 1990s did not show much difference in categories, with revenues recognized through Oil and gas royalties, Grazing lease rentals, Land sales, Interest, and Easements and sundry income. All along the way, land prices have appreciated, which, until recently, were more modest. HK’s 1995 thesis pre-dates the radical productivity unlocked by fracking and horizontal drilling by roughly 15 years. And it was only 20 years later that the company’s ambitions in source and produced water began to show in earnest. Alongside these more recent developments has been a proliferation of easements. Now, there is potential for data centers and related activities to become residents in the Permian, and, with them, presumably a significant increase in the need for everything that TPL monetizes.

Texas Pacific Land Corporation: The Riches of Royalties

Imperial’s main business, in the plainest terms, is to continue to embrace the mighty cigarette. There are also benefits associated with Logista’s expansion and related distribution income. There is also the potential for NGPs to further enhance the business.

It may feel a bit off to compare fracking and next-gen nicotine products, but it is fair to say that each has and will continue to have a radical impact on their respective industries. It is equally fair to dismiss the expectation that Imperial Brands will directly capture the same benefits from NGPs as its competitors. The company remains unbelievably cautious in investing in new categories. The key point to acknowledge here is that just as HK’s TPL thesis excluded future catalysts, no radical catalyst is needed for Imperial.

In the math provided by HK, the primary driver of forward returns would not be share price appreciation. In fact, alongside the dividend, the share price was illustrated to remain flat. There was no expectation of radical changes to the business or entirely new operating segments. Instead, given the business’s capital-light nature, the key driver would be the use of excess profits for share repurchases. Each year, repurchases would trim not just the number of shares, but also the absolute dividend paid. This would free more capital to be redeployed in larger repurchases each year, accelerating over time.

Two exercises were illustrated. In Exercise 1, revenues were kept flat from 1995 to 2010. In Exercise 2, revenues grew by 3% per annum over the period. These are not exactly heady figures (TPL’s 2010 report shows the actual revenues realized in 2010 were $20 million, roughly double HK’s second scenario). Yet, the cumulative effect of repurchases, should the share price remain flat, would be magnificent. Exercise 2 showed a 96% decline in shares outstanding over roughly 15 years. Exercise 1, with flat business performance, still resulted in the share count decreasing by 46% over the period.

I will not try to argue that Imperial’s business is precisely as durable. Nor would I pretend that its core business is as capital-light as royalties. But I am quite happy to point out that it doesn’t need to be.