Given the prevailing narrative, shareholders could be forgiven for thinking that tobacco companies (like their principal clientele) are facing an existential crisis – albeit a rather drawn-out one. Every year the two major UK-listed tobacco companies, British American Tobacco (BATS) and Imperial Brands (IMB), sell fewer cigarettes than the year before – death by a thousand butts. The latest half-year figures bear this out. Imperial Brands reported that cigarette volumes had fallen by 5.7 per cent, compared with an industry-wide decline of 4.3 per cent. Similarly, BATS sold 5.6 per cent fewer cigarettes over the comparable figure in 2016. It makes you wonder how these cheroot vendors will be able to maintain their status as ‘sin stocks’ when sinners are patently a dying breed.
The rise of health consciousness – at least in western societies – coupled with an increasingly punitive regulatory environment are pushing tobacco companies into alternative yet complementary markets, like vaporised nicotine products, or devices that simply heat rather than burn the tobacco. Imperial Brands has even invested in a caffeine-based, low-calorie product designed to give users a boost of energy (which sounds remarkably like a cup of coffee). The companies are also trying to juice their margins by attempting to get those customers that do smoke traditional cigarettes to buy the more expensive premium varieties. Presumably, this presents something of a logistical challenge since the advent of plain paper packaging.
Smoking at the margins
Nonetheless, the strategy to move smokers on to pricier brands may be having the desired effect. Even though fewer cigarettes are being sold, this has yet to translate to a squeeze on revenue. Imperial Brands saw turnover improve by 11.7 per cent over the half year to £14.3bn, while revenue at BATS was up 15.7 per cent to £7.7bn. Non-sterling denominated revenue streams did have a marked impact, but there were still gains regardless of currency effects. The logic is straightforward; if you’re perennially selling fewer fags into your traditional markets then you may as well convince the punters to spring for a premium product. Imperial’s hawking of specialist brands, including Style and Kool, fed through to a 200 basis point improvement in sales of its 'growth and specialist brands', which now generate 60.4 per cent of revenue net tobacco. At the same time, BATS expanded its share of key markets driven by what it has dubbed its 'global drive brands', such as Lucky Strike and Pall Mall.
Planet of the vapes
Another reason why revenues have held up is because both big tobacco companies have moved deeper into the market for alternative or complementary products. E-cigarettes or vaporising products, which deliver nicotine through tiny particles, are becoming more common. BATS has expanded its range of 'next generation products' into 15 markets and has become the largest vapour company in the world. It is the market leader in the US, UK, and Poland through the Vuse, Vype and Ten Motives vapour products. And the global market is opening up. The glo vaporiser now has an 8 per cent market share in the Japanese city of Sendai – where it first launched – with plans to extend coverage in Tokyo, Miyagi and Osaka before eventually rolling into Canada and Switzerland. Imperial Brands is looking to establish its place in alternative products through its subsidiary Fontem Ventures. It is tasked with growing the sales of the e-vapour brand blu along with licensing a range of patented technologies.
A taxing time in emerging markets
Aside from the diversified product offering, tobacco companies are still pinning their hopes on emerging markets where consumers are becoming wealthier and may not be adequately informed as to the health risks. Hitherto, this was largely due to the undue influence exerted by tobacco companies at a governmental level, but emerging markets are not the growth panacea they once were. Several economies have hiked taxes on the sector to bolster their treasuries, something that has stalled the rise in cigarette volumes. Smokers in China are no longer allowed to light up indoors, nor in some outdoor public places, and anyone who does so is faced with a fine. And in India users of chewing tobacco will now have to pay a 160 per cent levy on their purchase of the product. Nevertheless, when you consider that China alone accounts for 300m smokers – or one in every three cigarettes smoked globally – the likes of BATS and Imperial Brands will continue exploiting the changing demographics in these markets.
On the regulatory front
Regulators on both sides of the pond do not appear ready to give the tobacco lobby a break anytime soon. Prior to 1996, the laws governing the sale of tobacco products fell within the jurisdiction of individual state laws, but then the US Food and Drug Administration (FDA) decided to get involved. It wasn’t until 2009, however, with the passing if the Family Smoking Prevention and Tobacco Control Act by the United States Congress that the FDA was finally able to bring the full weight of its statutory authority to bear. And the tobacco companies have been on the back foot ever since. The latest regulatory wheeze, so to speak, centres on a proposal to restrict the amount of nicotine allowed in combustible cigarettes to non-addictive levels. In addition to lowering nicotine levels, the FDA will also look at the role different flavours play in combustible tobacco products to make them less appealing, especially to new users.
The FDA announcement sent shares in BATS down 7 per cent on the day and Imperial Brands by around 4 per cent. The former experienced a steeper fall because it has recently completed the acquisition of American tobacco brand Reynolds, bringing its US exposure to 43 per cent of revenue compared with Imperial Brand’s 23 per cent. More than 5 per cent of the total cigarettes consumed around the world are in the US, making it the third-largest market.
