US: Big Tobacco’s Boom Time as Cigarette Revenue Soars

Source from:  The Australian 04/26/2017

It’s a great time to be a cigarette company again.

Far fewer Americans are smoking, and yet US tobacco revenue is soaring, thanks to years of steady price increases. Americans spent more at retail stores on cigarettes in 2016 than they did on soft drinks and beer combined, according to independent market--research firm Euromonitor International. Consolidation and cost cutting are boosting profit. Big Tobacco shares are on a roll.

Two decades ago, such a boom didn’t seem possible. The industry faced a future of increasing regulation and declining sales, as older smokers quit and fewer young people picked up the habit. States were suing for billions of dollars. Bankruptcies for some players seemed just around the corner.

Things didn’t turn out so badly, though. Costs from an avalanche of legal settlements and regulatory requirements have been heavy, but they haven’t put any big players out of business. Cigarette makers found they could more than make up for falling volumes with higher prices.

"We came out of a challenging period," said Marty Barrington, chief executive of Marlboro maker Altria Group.

The number of cigarettes sold in the US fell by 37 per cent from 2001 to 2016, according to Euromonitor. Over the same period, though, companies raised prices, boosting cigarette revenue by 32 per cent, to an estimated $US93.4 billion ($123.5bn) last year. An average pack in the US cost an estimated $US6.42 in 2016, up from $US3.73 in 2001, -according to TMA, an industry trade group.

A flurry of consolidation has winnowed the US tobacco market from seven big players to two: Altria and Newport maker Reynolds American, which together sell eight out of every 10 cigarettes in the country. As companies combined, they squeezed out costs and increased pricing power, along with profits.

The operating profits of US tobacco manufacturers have grown 77 per cent since 2006 to $US18.4bn in 2016, according to Bank of America Merrill Lynch Global Research. Industry executives and analysts now figure the country generates more tobacco profits than any other market in the world outside China, where a state-run monopoly controls sales and prices.

Johnny Cagigas oversees the machines that spit out as many as 10,000 "sticks" a minute at Reynolds American’s plant. He started in the industry 20 years ago, and remembers the pressure and worries over an uncertain future.

When he tried to fill positions in the late 1990s at a Brown & Williamson factory in Macon, Georgia, he says job candidates would ask, "Do you think they will shut you down?" Many refused offers.

"In a blessed way, I started at the right time, because now I’m getting to ride a wave that people were used to back in the 60s and 70s," he says in his office inside a complex where overhead conveyor belts push along neatly stacked Newports. Robots squirt orange liquid into e-cigarette cartridges. "Uncertainty doesn’t faze us a whole lot now," he says.

Investors are also cheering. In 2000, US tobacco companies’ price-to-earnings ratios were about a third of their consumer-staples peers’. Today, they’re roughly 10 per cent higher, according to Morgan Stanley. The S&P 500 Tobacco Index fell 22 per cent between 1998 and 2002. Over the past decade, it’s up 178 per cent, outperforming the broader S&P 500, which climbed 58 per cent.

The industry sells 5.5 trillion cigarettes each year to the world’s one billion smokers. In many ways, the US has become attractive again as opportunities around the rest of the globe wane.

Taxes are often lower in the US than elsewhere in the developed world, according to World Health Organisation data. About 42 per cent of the average US pack price is tax, according to TMA. In Britain, meanwhile, taxes make up 82 per cent of the average pack, which sells for about $US10.90, or about $US4 more than the average US price, according to Britain’s Tobacco Manufacturers’ Association. Thanks partly to the First Amendment, US tobacco makers also aren’t constricted by some of the more stringent branding and health-warning rules introduced elsewhere. In Britain and Australia, cigarettes are sold in drab, greenish-brown packs with a large health warning and a graphic photo illustrating smoking’s risks, from diseased lungs to blindness.

Some Middle Eastern and African markets are growing, thanks to rising populations and income. But in much of the rest of the emerging world, smoking is on the decline, with less opportunity than in the US to boost prices to make up the difference.

China is by far the world’s biggest market, where state-owned China National Tobacco sells 44 per cent of the country’s cigarettes. In 2015, volumes fell there for the first time in two decades after big tax increases. Russia, the world’s second-biggest market, restricted advertising and banned smoking in public places in 2013. Those moves cut volumes sharply. While all that makes the US relatively more attractive, it also underscores the existential threat hanging over the industry. No one expects volume declines anywhere to reverse, and price hikes can make up for that for only so long.

Tighter regulation and higher taxes remain big threats both in the US and abroad. On April 1, California raised cigarette taxes by $US2 a pack. And last week, New York Mayor Bill de Blasio threw his support behind proposals to raise the minimum price per pack to $US13, from $US10.50 and, through attrition, slash the number of tobacco retailers.

A US law passed in 2009 leaves open the possibility that the Food and Drug Administration could one day ban menthol cigarettes — a major revenue driver for Newport owner Reynolds — based on the agency’s 2013 finding that they probably pose a greater health risk than regular cigarettes. The law also gives the FDA the authority to mandate the reduction of nicotine levels in cigarettes to near zero.

Faced with these headwinds, tobacco executives know today’s boom won’t last forever, and are investing heavily to develop products they say are safer.

Altria and Reynolds both have diversified into smokeless tobacco — a market still growing by volume. Reynolds sells nicotine gum, while Altria owns a wine business in Washington state and has a 10 per cent stake in Anheuser-Busch InBev, the world’s largest brewer.

Philip Morris International, spun off by Altria in 2008 to pursue non-US business, has spent $US3bn developing next-generation products, including a device called IQOS that delivers nicotine by heating sticks of tobacco instead of burning them. Philip Morris says its internal studies have shown that by avoiding combustion, the product prevents or reduces the release of harmful compounds. The company has asked the FDA for authorisation to market IQOS as less harmful than cigarettes through a partnership with Altria.

British American Tobacco, which makes Dunhill and Pall Mall, spent $US1bn over the past five years developing so-called next-generation products, including its vapour brand Vype and its own heat-not-burn product.

For now, though, revenue from those products remains a tiny slice of overall sales. Until they start to catch on more broadly, tobacco executives must rely on traditional cigarettes.

"The focus really is, how do we sustain our revenues from combustible products, which fuel the innovation for next-generation products?" said David O’Reilly, BAT’s head of research and development.  Enditem