Tobacco Industry: LAKSON TOBACCO COMPANY - Analysis of Financial Statements fiscal year 2002 to fiscal year 2006
The tobacco industry in Pakistan is oligopolistic with two major players in market, belong to the organised sector and a few minor players in organised and many in the unorganised sector. Lakson Tobacco is Pakistan's second largest tobacco company, with an estimated cigarette volume of 29.8 billion units in fiscal year, ending 30 June, 2006. The company held an estimated 47% share of the growing 63 billion-unit Pakistan cigarette market.
THE COMPANY OPERATES THE CIGARETTE BRANDS, NAMELY:
-- Park Lane
-- Premier Classic
-- Red & White
-- Morven Gold
-- Princeton
-- K2
-- Diplomat
Morven Gold is its leading brand with an estimated 37% market share, complemented by Diplomat and Royals. Additionally, Lakson Tobacco is the licensed manufacturer of PMI's Marlboro and Red & White brands in Pakistan.
The company concentrates on the lower-value brands. In March 2007, Phillip Morris International acquired 50.21% shares of Lakson Tobacco Company. As a result of this acquisition and combined with PMI's existing 40 percent stake in Lakson Tobacco and an additional 7.41 percent shares irrevocably tendered by shareholders, PMI will own approximately 97.62 percent of Lakson Tobacco.
During FY06, the company posted a gross turnover at the same level such as FY05. Better control over cost and expenses, resulted a 2.4% increase in the gross profit. However the net profit registered a 7.4% decline.
LTC is more competent in terms of profit margins, as compared to only large player in organised sector of tobacco industry of Pakistan. The gross profit margin of LTC has been rising very slow for the last few years and FY06 saw no change in the trend. The net profit margin, however, suffered a slight setback in FY06. Nevertheless, the gross and net profit margins of the company continued to hover above those of its major competitor.
The decline in profitability can be attributed largely to increase in marketing and distribution expenses, which led to lower profits as compared to FY05 and a subsequent fall in net profit margin.
The decline in profits pulled down the ROA and ROE of the company for FY06. Initially, before FY05, the ROE and ROA had been higher than its competitor but FY05 witnessed a change in the trend as ROA dropped below its competitor. A further decline in FY06 has resulted in the ROE also falling to an inferior position.
LTC performs better than its competitor in terms of liquidity management. The current ratio of the company has remained higher than its major counterpart in the industry. However the FY06 saw an improvement in the composition of current assets of the company as level of the cash and bank balances declined. Previously, the company had been retaining large amounts of cash and bank balances which may have been better invested in more profitable other assets. The new arrangement may reflect a better allocation of resources.
LTC fares better than its competitor in terms of management of inventory as the inventory turnover (days) of LTC being lower than the competitor. However the company lags behind in collection of receivables. Even though the DSO is low, but it hovers above the DSO of the competitor. The collection period had soared in FY05 but the condition was controlled to a large extent in FY06, and the DSO has been considerably lowered. The operating cycle had been lower than that of its rival until FY06, where an increase in inventory turnover resulted in lengthening the operating cycle. Now the company stands at par with its competitor as regards the operating cycle.
The total asset turnover and sales to equity ratios of LTC are notably lower than the company's counterpart. Hence overall, LTC occupies a secondary position in the industry when it comes to the effective and efficient management of assets.
The financial position of the company has been improving throughout the five-year period studied. This is reflected in the diminishing debt ratios of the company during the five-year period. The company has maintained a commendable standing in terms of debt to asset and long term debt to equity ratios as compared to the competitor. Prior to FY06, the debt to equity ratio was higher but the company managed to catch up with its rival in FY06 and has now superseded the other company.
The company's financial strength is also evident from the high times interest earned ratio, which soars high above the interest coverage ratio of the rival company. The decline in the ratio in FY06 can be attributed to the lower operating profit for the year.
The EPS registered a decline in FY06 in line with decline in profitability. The book value of the company's shares also dipped slightly in FY06 owing to an increase in the equity base of the company.
RECENT RESULTS:
During the first nine months of FY07, the turnover grew by 9.3% to Rs 16.012 billion as compared to Rs 14.654 billion in the same period last year. Consequently, the gross profit has increased by 2.1% to Rs 3.163 billion as compared to Rs 3.099 billion in the previous nine months. However, a reversal of provision of sales tax amounting to Rs 204.486 million in the previous period had increased the gross profit by Rs 204 million. Discounting the effect of this reversal, the gross profit has increased by Rs 268 million (9.3%) to Rs 3.163 billion as compared to Rs 2.895 billion during the same period last year.
However, a 7% increase in distribution and marketing expenses to Rs 1.044 billion and 5% increase in administrative expenses to Rs 226 million has offset the growth in gross profit so that the operating profit has decreased by 1% to Rs 1.798 billion as compared to Rs 1.813 billion in the comparative period last year. Net profit after tax not shown any growth during the period. This increase in expenses was in line with the inflationary trend.
-- A decline was seen in both net and gross profit margins for this period.
-- Government regulation and its impact on the industry:
-- The tobacco industry has to bear the burden of high excise duties on its products. The rates on various varieties are:
1. 63% on premium brands
2. 50-58% on mediocre brands
3. 42% on low quality brands
Moreover, Pakistan has ratified the Framework Convention on Tobacco Control (FCTC), which is the world's first global agreement devoted entirely to tobacco control. The FCTC is an agreement amongst many countries to restrict advertising of tobacco. The agreement calls for prohibition of advertising in the print and electronic media. It only allows for promotion to take place within the shop and on its boards.
In addition, the government has passed the Prohibition of Smoking at Public Places and Protection of non-smokers Health Ordinance of 2002, which aims to stop people from smoking in public. It also includes restriction of promotional campaigns of the tobacco industry. This law is also the first statutory move to regularise promotional campaigns of the tobacco industry.
At present all forms of cigarette advertising have been banned (including TV and billboard advertising) as tobacco industry's claim that their advertisements were designed to convince existing smokers to change brands and not to attract youngsters has been merely rejected. Sale of cigarettes to people under the age of 18 is also restricted.
Furthermore, every pack of cigarettes bears the warning regarding prohibition of its sale to individuals below 18 years. It is obligatory on every firm to print a health warning on each cigarette pack. No vendor can sell cigarettes within a radius of 50 metres from any college, school or other educational institution. Violators of this law shall be fined.
The adoption of the FCTC has forced companies to become more socially responsible but the ban imposed on advertising and promotional activities has limited the reach of the industry. Therefore the recent signing of the Framework Convention for Tobacco Control (FCTC) has setback the industry considerably, which will have larger repercussions in the years to come. The true effect of this will be visible over time as almost 50% of the Pakistan population is under 24 and the potential smokers will not be advertised to leading to a loss in demand.
But the true effect is dependant on the strictness with which the rules are followed. Although the above given rules seem to be dampened on the future demand, but the real situation is evident for all to see.
FUTURE OUTLOOK:
The acquisition of the company by PMI and the subsequent changes in the management may bring about significant changes in future as the new management is focused to bring an improvement in the overall performance of the company. With the expertise available internationally in all the fields, the company is poised to grow. This will be achieved through strategic marketing activities, cost control measures, development of human resource and bringing about improvement and advancement in technology.
Moreover, the government's ratification to the FCTC may be a source of concern for the company as it may adversely affect the sales and distribution of its products.
The company also faces serious problem of smuggled and counterfeit cigarette brands. Smuggling brings in expired and improperly stored cigarettes into the market which ruins the brand image and loyalty of the consumer as its taste is not fresh and as strong as that of the original product. Smuggled products mostly enter from Afghanistan and Iran; however exports from South Korea, UAE and Bangladesh are also becoming a nuisance. It is hoped that the government will further enhance its efforts to curb the production of counterfeit cigarettes in order to protect the loss of government revenue and the tax paying tobacco sector.
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LAKSON TOBACCO COMPANY
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BALANCESHEET (Rs '000) 2003 2004 2005 2006
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Total Non-Current Assets 1092090 1548269 2154564 2479614
Total Current Assets 2822747 3474141 3538297 3501389
Total Assets 3914837 5022410 5692861 5981003
Total Current Liabilities 1797024 1757620 1365019 836094
Total Equity 1918182 3093634 4145491 4956281
Long Term Debt 185633 157500 174078 188628
Total Debt 1982657 1915120 1539097 1024722
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INCOME STATEMENT 2003 2004 2005 2006
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Gross Turnover 15746083 17307599 20584045 20619711
Cost Of Sales 12891964 14158084 13767718 13895849
Gross Profit 2854119 3149515 4080287 4176547
Distribution And Marketing Exp 1179676 884051 1065338 1381169
Administrative & Selling Expenses 269102 190311 282831 297997
Operating Profit 1405341 2075153 2732118 2497381
Other Operating Income 32943 31992 55654 68259
Other Operating Expenses 97077 158872 206743 174862
Profit From Operations (EBIT) 1341207 1948273 2581029 2390778
Finance Cost 39976 19166 9079 10654
Profit Before Taxation 1301231 1929107 2571950 2380124
Taxation 444448 651363 886913 825239
Profit For The Year 856783 1277744 1685037 1554885
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KEY RATIOS
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PROFITABILITY 2003 2004 2005 2006
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Return on Asset 21.89% 25.44% 29.60% 26.00%
Return on Common Equity 44.34% 41.12% 40.57% 31.37%
Gross profit margin 18.13% 18.20% 19.82% 20.26%
Profit margin 5.44% 7.38% 8.19% 7.54%
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LIQUIDITY RATIO 2003 2004 2005 2006
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Current Ratio 1.57 1.98 2.59 4.19
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ASSET MANAGEMENT 2003 2004 2005 2006
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Inventory Turnover 39.77 32.56 21.11 37.92
Operating cycle 41.09 32.99 34.58 39.68
Day Sales Outstanding* 1.32 0.43 13.46 1.76
Total Asset turnover 4.02 3.45 3.62 3.45
Sales/Equity 8.15 5.57 4.96 4.16
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DEBT MANAGEMENT 2003 2004 2005 2006
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Debt to Asset (%) 50.64% 38.13% 27.04% 17.13%
Long Term Debt to Equity (%) 9.61% 5.07% 4.19% 3.81%
Debt to Equity Ratio (%) 102.61% 61.63% 37.05% 20.68%
Times Interest Earned 33.55 101.65 284.29 224.40
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MARKET VALUE 2003 2004 2005 2006
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Earning per share 20.04 24.90 32.84 25.25
Price earning ratio 5.24 8.84 7.87 11.80
Book value 91.54 97.87 110.94 97.13
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COURTESY: Economics and Finance Department, Institute of Business Administration, Karachi.
DISCLAIMER: No reliance should be placed on the [above information] by any one for making any financial, investment and business decision. The [above information] is general in nature and has not been prepared for any specific decision making process. [The newspaper] has not independently verified all of the [above information] and has relied on sources that have been deemed reliable in the past. Accordingly, the newspaper or any its staff or sources of information do not bear any liability or responsibility of any consequences for decisions or actions based on the [above information].
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