Cigarette makers are bracing for a potential drop in demand and a fierce price war, after Big Tobacco failed to overturn an Australian law last month calling for plain wrapping on their products. Since then, fear has mounted that generic packaging will not only hurt the premium brands that rely on distinct branding but will also trigger an illicit, counterfeit trade that will have major implications across the entire industry.
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The developments have scared the investor community, with major tobacco firms lagging their regional stock indexes since the ruling. Imperial Tobacco Group PLC and British American Tobacco PLC have each dropped more than 6.5%, while the Stoxx Europe 600 index, a broader gauge of markets in the region, by comparison, has gained 1.6%. "It's common sense that if you make all packs look the same, it's easier for criminals to counterfeit them and pass them on to consumers. That is a real concern and a real threat," said Simon Evans, a representative for Imperial Tobacco Group. "We wouldn't expect to see less people smoking, but would expect those people to smoke less-legal products." The Tobacco Plain Packaging Act will come into effect on Dec. 1 in Australia and see cigarettes packets stripped of any individual branding, with only the company name in a gray, Lucida Sans font at the bottom. In addition, a warning and a picture of lung cancer, gangrene, rotten teeth or other consequences of smoking will take up at least 75% of the front. And the industry is concerned it's not going to stop at Australia's borders. Norway, India, France and Canada are already considering bans on cigarette branding, while both the U.K. and New Zealand are looking specifically at introducing plain-packaging laws. Russia is also considering adopting the idea while also looking into a ban on smoking in public places. In the U.S., the Food and Drug Administration is not seeking to ban branded packets but will require larger, more prominent health warnings on all cigarette packaging and advertisements. The move is the first change in cigarette warnings in more than 25 years in the U.S. and is "expected to have a significant public health impact by decreasing the number of smokers," according to information available on the FDA's website. The rollout was planned for September this year, but continuing litigation has delayed implementation. Still, a representative from the FDA declined to comment on the potential commercial implications for tobacco firms in the event plain-packaging were to be introduced to the U.S. market. U.S. tobacco stocks have nevertheless been under pressure since the Australian ruling in August. Philip Morris International Inc. shares have lost 1.8% and Lorillard Inc.'s stock is down 4.6%. By comparison, the S&P 500 index has added about 4% during this time. Illicit trading on the rise Analysts, along with the major tobacco firms, fret that plain packages will boost an already significant market for illicit trade in cigarettes, which could erode sales volumes for established tobacco brands. Erik Bloomquist, analyst at Berenberg Bank, said that smokers could lose the incentive to buy legal cigarettes in a market offering the same drab packaging across all of its products. On top of that, criminals could find it easier to counterfeit the new packaging as well as finding a new, potentially lucrative market for older, "vintage" versions of cigarette wrappers. "If we look back at what happened in 2010 when the Australian government took taxes on cigarettes up 27% it drove a big increase in illicit trade, which went up 4%, costing the government an additional A$500 ($529 million) in tax," Bloomquist said. "But the industry was still able to grow revenue and earnings, just on the pricing," he added, explaining that existing smokers would likely stick to their preferred brand of tobacco. He also said the market's plain-packaging fears could prove unfounded, and the recent dip in share prices could be a good time to buy tobacco stocks. However, others say tobacco firms may not be able to use the pricing tool to mitigate new, strict regulations this time around. Evans from Imperial Tobacco said that pricing "would pretty much be the only thing left to compete on if you take the branding possibilities away." And British American Tobacco said in a statement after the Australian ruling that plain packages "would have other significant, adverse unintended consequences, including driving down prices." John Noble, director of the British Brands Group, said that with no marketing platform to catch the eyes of consumers, tobacco firms will have a hard time communicating any changes in quality or taste, making it harder for smokers to differentiate one product from another. "The companies should be worried because it changes the dynamics of the entire market from being driven by quality, innovation and reputation to one that will be predominantly 'commodified' and price-led," he said. More specifically, without the branding value of the premium brands, some smokers may opt for a value brand or go for an even cheaper, counterfeit cigarette packet carrying the old logo and recognizable colors. Martin Deboo, an analyst at Investec Securities said, "Pricing is a threat. People won't pay for a premium brand if they can't get the brand value." Tobacco firms have already been hurt by strong government efforts to curb smoking. Total cigarettes sales since 1997, by volume, have dropped by 5% globally, excluding China where the market is state controlled. The drop has been largest in North America, Australasia, Western Europe and Latin America, where volumes have declined 36%, 27%, 20% and 19% respectively, according to data from Euromonitor and Berenberg Bank. Sales are rising in the Middle East, Africa and Eastern Europe. Enditem
