Cigarettes: on a roll

Smoking is not injurious to corporate health. Official data show that cigarette producers are having a ball. Some 29 billion cigarette sticks were produced in Pakistan in 1HFY18, as per the Pakistan Bureau of Statistics (PBS). That’s a 70 percent growth year-on-year and a 68 percent growth over the previous six months. As things stand, cigarette producers may achieve a similar output in 2HFY18.

Given the alarming rise of illicit cigarettes – which are mostly locally-produced, duty-non-paid (DNP) brands being produced and sold at the expense of the formal sector – in recent years, it is difficult to estimate the quantum of actual local production in this market. Illicit share stood around 20 percent of overall cigarette sales (by volume) in 2011, a stake that had doubled by the middle of 2017.

But if the latest PBS data is any guide, the formal-sector production is returning to its normal output level, which averages just over 5 billion sticks a month in the last ten years. With that as a guide, production will tally over 29 billion sticks in 2HFY18, yielding a growth of 68 percent year-on-year. That quantum would have local cigarette production grow around 69 percent year-on-year for the full fiscal year.

The rise in formal production is apparently coming at the expense of DNP brands. Years of FED-driven price hikes after every budget announcement had widened the price differential between legitimate brands and duty-evading brands. The formal sector took a severe pounding in FY17, when prominent players like Pakistan Tobacco (PSX: PAKT) and Philip Morris Pakistan (PSX: PMPK) lost a major chunk of their cigarette volumes, especially in the value-for-money (VFM) segment, to duty-evading brands.

That translated into a significant reduction in government taxes from the formal sector. Alarmed, federal government, through the FY18 budget announced in late May 2017, acted to reverse the slide of formal sector sales. On one hand, it only marginally increased FED on two exiting pricing tiers. And on the other, a third, low-price tier was introduced – where cigarettes could retail below Rs58 per pack.

This third tier helped take the fight to the illicit brands in the affordable, VFM segment as cheaper cigarettes arrived in the formal market, closing the price differential with the illicit, duty-non-paid brands.

While this government move has drawn criticism from public health advocates, the corporate financials have seen a remarkable turnaround since those fiscal measures went into effect in Jul-Dec 2017 period.

For instance, PAKT, the market leader, has bounced back. Compared to the rout in Jan-Jun 2017 – when its gross revenues were down 39 percent and bottom-line declined 58 percent year-on-year – the Jul-Dec 2017 period yielded the firm a gross turnover growth of 32 percent and a net profit surge of 101 percent year-on-year. PMPK’s financials also showed significant yearly amelioration in the Jul-Sep 2017 quarter; more improvements are expected in the subsequent quarter (latest results are due March 15).

So, as PAKT and PMPK have been experiencing a much more favourable operating environment lately, they might keep utilizing their capacity to the maximum. As might smaller players in the formal market, like Khyber Tobacco (PSX: KHTC). As those fiscal measures are still in place, the tobacco high may last until at least the next budget announcement in a few months.