Cigarettes in 9MCY22

Given the unprecedented crises facing the country this year, one might think Pakistani smokers would have increased their consumption. But that’s not quite the story official data has to tell. The country’s overall cigarette manufacturing is rather showing a decline this year. Using latest data from the Pakistan Bureau of Statistics (PBS), one can see that the formal industry’s cigarette output stood at 39.6 billion sticks in the Jan-Sep period of CY22, signifying a fall of 5 percent year-on-year compared to 9MCY21.

The output this year was actually on a growth path until June 2022. But after the federal budget that month raised the federal excise duty (FED) on both the value tier (affordable) and the premium tier (pricey) of cigarettes, it disappointed the expectations of the formal industry players, who were hoping that the new government would keep the FED unchanged just as it was in the previous two years. Not only that, another FED hike later came in the month of August, further dismaying the formal players.

What has followed since is a large output drop. Based on the PBS data, the cigarette production in the post-budget quarter (Jul-Sep 2022) witnessed a sharp decrease of 31 percent year-on-year to reach 10.4 billion sticks. This was the first output decline for a post-budget quarter since Jul-Sep 2019. The output slide in 3QCY22 was mainly because just 1.02 billion cigarette sticks were produced in the post budget month of July 2022, a decline of over 75 percent on both month-on-month and year-on-year bases.

Comparison with historical data show that from July 2022 output was the lowest monthly production on record for tobaccos in recent years. Production picked up in subsequent months: 4.3 billion sticks in August and 5.07 billion sticks in September. But on a year-on-year basis, those figures are still lower by 18 percent and 11 percent, respectively.At current monthly average in 9MCY22, full-year CY22 output can reach 52.7 billion sticks, which will still be 7 percent smaller than 57 billion sticks produced in CY21.

While the output remained under pressure in 9MCY22 in the official data, the top two tobacco firms still managed to score strong gains in topline and bottomline, as per their recent corporate results announcement to the bourse. The year-on-year growth in net turnover (portion of revenue which remains with the firm after deducting FED and GST) was reported by market leader Pakistan Tobacco Company Limited (PSX: PAKT) at 27 percent and by Philip Morris (Pakistan) Limited (PSX: PMPK) at 17 percent.

The topline appears to be strong for two plausible reasons. One, the market players chose to raise prices in order to pass on the impact of rising costs (and FED) to consumers. And two, it appears that bulk of the growth in revenues took place in value/affordable tier as opposed to premium pricing segment. Still, the real boost to the financials came when despite rising cost pressures, the operating profits for both firms jumped proportionally higher relative to the topline. This was mainly thanks to operational efficiencies.

Company financials show that PAKT recorded 36 percent increase and PMPK 28 percent increase on a yearly basis in their respective operating profits. In the end, net profit growthyear-on-yearwas relatively lower (at 18 percent for PAKT and 15 percent for PMPK), which mainly shows the impact of higher income-tax expenses booked in 1HCY22 due to the super-tax imposed by the federal government.

Market players often warn after every FED hike that it is going to hurt their sales and financial performance (and also government’s tax collection), as FED hikes purportedly make the formal industry less price-competitive against informal players that evade taxes and duties. Indeed, as identified earlier, there has been a big drop in output in the government-reported data for the Jul-Sep 2022 period. However, latest company data, for the same quarter, show that PAKT and PMPK still managed to score strong topline and bottomline growth. Let’s see what the final quarter of the year has in store for the duo.