Feb 2, 2011
Britain’s Imperial Tobacco looks better placed than rivals with more expensive brands if plain packaging rules for cigarettes spread from developed to emerging markets, as health warnings did.
New rules are being explored in Australia and Britain, but analysts say the real risk from plain packaging is if it spreads to emerging markets, where it would slow consumers moving to more pricey and profitable brands.
Smokers in big emerging markets such as Brazil, Russia and Indonesia aspire to top western brands such as Marlboro and Lucky Strike cigarettes, which confer status on the individual and bigger margins to the maker.
Plain packaging interferes with that mechanism, helping makers like Imperial, with its focus on low-priced brands such as Lambert & Butler.
In mature markets, where Imperial makes 70 percent of its profits, packaging changes are expected to have a relatively low impact on smokers’ choices.
London-based BAT has a 50-50 split of earnings from mature and developing markets, and three of its four top brands — Lucky Strike, Kent and Dunhill — are premium priced.
“Plain packaging looks to be far less risky for value players … So far, Imperial Tobacco looks better placed versus its peers,” said analyst Chas Manso at Evolution Securities.
“We believe plain packaging would be negative for the entire tobacco industry, but we are doubtful it would represent a nemesis, especially not in mature markets. But it could knock out the main premiumisation driver in emerging markets.”
BAT’s two biggest global markets are in Brazil and South Africa, and analysts say the key to profitability there is luring smokers from cheap local to premium brands.
“With the price gap between premium and discount brands across the global typically around 35-40 percent, those with big brands in emerging markets will suffer,” said one analyst.
These include the world’s three biggest cigarette groups Philip Morris International, with its Marlboro brand, BAT and Japan Tobacco, with its Camel cigarette brand.
Analyst Adam Spielman at Citi says industry profitability depends on consumers paying premiums for some brands, and plain packaging would reduce the power of the brand, especially expensive brands growing strongly in emerging markets.
“We certainly don’t see plain packaging as any sort of positive for the industry. We think the uncertainty it provokes would well weigh on the multiples,” he said.
Worries over slow global recovery and plain packaging have rattled tobacco shares; Imperial and BAT have underperformed the FTSE 100 by 9 and 6 percent so far this year.
BAT shares trade on 12.4 times 2011 forecast earnings and Imperial 9.5 times, well below top-rated consumer stocks such as Reckitt Benckiser on 15 times, and analysts say concern over plain packaging could widen that gap.
Australia and Britain are looking at rules to force cigarette makers to sell their products in plain packages with the brand name in a standard typeface, removing the allure of attractive packaging, colours and logos.
Australia aims to introduce it by 2012. Its new government has not included the measure in its first legislation programme, but analysts expect a bill within 12 months.
Britain is considering introducing plain packaging and will publish a Tobacco Control Plan this winter to confirm its plans, while the European Union is expected to recommend that plain packaging should be considered.
Other countries are moving in a similar direction. Canada announced that health warnings would be required soon to cover 75 percent of both sides of the pack, and Uruguay has passed laws for 80 percent coverage. Analysts say the effect will be more or less the same as plain packaging.
Uruguay’s move could influence other emerging markets such as neighbouring Brazil, BAT’s biggest market.
No other countries have yet announced such plans.
Analysts add if plain packaging succeeds in commoditising the industry, it could raise pressure for takeovers to cut costs, and Evolution’s Manso says BAT and Japan Tobacco could be prompted into a break-up bid for world No. 4 Imperial.
Manso says BAT and JP have higher cost bases in Europe than Philip Morris and Imperial, and this may prompt them into a bid for the smaller Imperial, which would have to be a joint break-up bid to get around anti-trust problems.
A BAT spokeswoman said the group was strongly opposed to plain packaging as it removed the last way it can differentiate its product from its rivals and says the measure would simply encourage the production of more counterfeit cigarettes.
Source: FOREXYARD (February 1, 2011)