Pakistan Tobacco: FED hurts

Surprising that the leading cigarette maker posted a sizable decline in net profits in the opening quarter. As per latest financial results announced at the bourse, Pakistan Tobacco Company (PSX: PAKT) saw its 1QCY19 net profits decline by almost a quarter compared to same period last year. This happened despite a healthy growth in gross turnover, which is seemingly still enjoying volumetric growth.

The 27 percent yearly drop in PAKT’s operating profit for the quarter under review is majorly explained by one thing – the federal excise duty (FED) on cigarette sales. Showing 33 percent growth over same period last year, the FED grew disproportionately more than the gross turnover and the corresponding sales tax collected by the company in 1QCY19. What’s going on at the top?

The difference is that the FED rate – which is FED revenues as percent of gross turnover – stood at 50 percent in 1QCY19. That rate is significantly up from 43 percent reported in 1QCY18. Sales tax rate, as percent of gross turnover, remained at 15 percent in both periods. It appears that the controversial three-tier FED regime, which was announced two years ago to help formal industry, is giving diminishing returns to the top tobacco player.

At 50 percent of gross sales, the FED rate is also higher than the 46 percent level seen in CY17 and CY18, but closer to the 51 percent average seen between CY14 to CY16. Meanwhile, sales tax has averaged 15 percent of gross turnover in the last five years. The higher FED rate could be explained in that the multi-tier FED regime has seen two hikes since 1QCY18 – one in April 2018 and the next in September 2018.

In any case, higher FED reduced PAKT’s take for the quarter. Net turnover declined by nearly a billion rupees – the retained revenue equated 35 percent of gross turnover in 1QCY19, down from 42 percent in 1QCY18. There is not much to write about PAKT down below the income statement. The cost of sales, selling expenses and administrative expenses carved their usual slices of the sales pie. The three spending heads consumed 19 percent, 3 percent and 2 percent, respectively, of gross turnover.

In the end, PAKT closed the quarter with a net margin of 8 percent, down from 11 percent in 1QCY18. The upcoming budget is expected to raise the rates on FED slabs in line with inflation; so expect PAKT to retain less of its gross sales and thus post lower profits in subsequent quarters this calendar year. It might affect the financials even more if a double-digit increase in the FED is ordered by the government. Let’s wait and watch which way the smoke blows around budget time.