Challenging Year for Tobacco Industry

Source from:  The Star (my) 04/07/2009

LIEW Boon Tatt has been a smoker for over 20 years and he does not intend to stop any time soon. An educated man, he is fully aware of the health warnings on cigarette smoking and most recently the very graphic health warning pictorials plastered in the newpapers and cigarette boxes. "I know it is bad for my health but I don't have the will to stop. I may smoke less now as it is more expensive. But to tell you the truth I enjoy smoking - it is my one vice," he says candidly. Liew is not the only "hard-core" smoker around, millions of Malaysians are in the same boat. OSK Research is projecting only a 2% decline in the total industry volume (TIV) of tobacco this year with the implementation of the health pictorial warnings and weakening consumer sentiment. This is mainly supported by its recent in-house consumer survey which found that the demand for tobacco-related products is inelastic, whereby only 18% of the survey's respondents opted to reduce tobacco consumption, the lowest among other initiatives taken. "As long as the quantum of cigarette price increase is greater than the decline in tobacco TIV, earnings will still grow even as the industry experiences slower growth," it said. This provides some good news for tobacco companies such as British American Tobacco (M) Bhd (BAT), JT International Bhd (JTI) and Philip Morris (M) Sdn Bhd. Nevertheless, 2009 will be a challenging year for the tobacco industry which have been hit by higher excise duty, proliferation of illicit cigarettes, health pictorial warnings and a slowing economy. Pictorial warnings Total industry volume has generally been on a declining trend for the past five years from 16.32 billion sticks in 2006 to 15.38 billion last year. The use of pictorial warnings on cigarette packs which started on Jan 1 may dent demand to a certain extent as some, if not all, smokers will find the pictures rather disturbing. Although the industry has always been supported by resilient demand, new smokers may stay away from cigarettes as the pictures discourage tobacco consumption compared with seasoned smokers. Philip Morris managing director Richard Morgan sees reducing the prevalence of tobacco use as a legitimate public health goal. "If regulations lead to a reduction in adult smokers in the future then we say 'so be it.' Nevertheless, we will continue to compete for the business of those adult smokers who choose to smoke," he stresses. Meanwhile, BAT finance director Steve Rush believes it is still too early to quantify the impact of pictorial health warnings on the group's business. "However, it did contribute to higher operational costs," he adds. OSK cautions that other supporting initiatives, including nicotine patches, quit line services and media advertising, will certainly be detrimental to the Malaysian tobacco industry. Illicit cigarettes In addition to the growing competition within the value for money and premium tobacco segments, industry players are also having a tough time battling the illicit cigarettes trade which is eating away market share. According to statistics, the illicit cigarettes trade has been on the uptrend yearly from 14% in 2004 to 24.5% as at August 2008. Rush sees the ongoing high levels of illegal cigarettes which continue to persist at an average of 25.6% in the country as a key challenge to the industry. "The illegal cigarette trade was exacerbated by a high 20% excise increase in 2008 which resulted in higher price disparity between legal and illegal cigarettes. "Couple this with the impact of the current economic crisis on consumer spending power, discerning consumers who choose to continue to smoke may downgrade and buy cheaper alternatives such as illegal cigarettes," he says. JTI managing director Martyn Fraser Griffiths anticipates further tobacco control legislation and the Government continuing its policy of further excise tax increases. "As a result, the proliferation of illegal cigarettes will remain a significant threat. "While it is a common perception that the industry tends to be more resilient, it is very important to note that the industry is not immune to the negative effects of an economic slowdown and our biggest concern is that adult consumers will switch to illegal cigarettes," he says. Growth strategies OSK is keeping a neutral outlook for the sector as it sees the resilient demand in the long run mitigating the short-term shock from pictorial health warnings and the risk of greater competition. "We see the Big 3 players (BAT, JTI and Philip Morris) defending their respective market shares with the support of huge advertising and promotion at distribution points such as restaurants, entertainment outlets and shopping malls," it says. Philip Morris aims to defend and grow its business by building on its strong portfolio of premium international brands, focusing on Marlboro, L&M and A Mild. Morgan stresses that the company is constantly working on increasing efficiencies within its distribution infrastructure and sales force while maintaining strong relationships with its distributors. "We will also continue to focus on growing our share in our key brands in the premium segment through our brand-building activities at the retail side and ensuring that adult smokers choose our brands over our competitors," he says. BAT's global drive brands Dunhill, Kent and Pall Mall have performed well last year and achieved volume growth resulting in a total market share of above 50%. Rush says BAT's investments last year to drive brands and improve its marketing and distribution capabilities will help to maintain its market leadership in the tobacco industry this year. "We will maintain our dividend policy of returning excess cash to shareholders by paying at least 90% of profit after tax in dividends. We also have an aim to increase the earnings per share each year. "We believe that we will be able to achieve both of these in 2009," he adds. BAT's net profit rose 10.9% to RM811.7mil for the year ended Dec 31, 2008 versus 2007 while revenue was higher by 7.9% to RM4.13bil. Total dividend payout for the year amounted to RM2.65 per share. OSK says: "Despite our cautious view and the limited upside potential, we need to emphasise that BAT and JTI have the capability to pay generous dividends. "We are projecting that BAT and JTI will offer yields of 8.2% and 8.1% in financial year 2009 respectively on the back of dividends of 365 sen and 37 sen per share. This assumption is premised on a payout ratio of about 100% for BAT and 73% for JTI," JTI recorded a 21.1% jump in net profit to RM98.1mil for the year ended Dec 31, 2008 versus 2007 while revenue grew 20.5% to RM1.03bil. The group paid dividend of 58 sen per share for 2008. Enditem