It pays to build scale. The tobacco market leader seems is weathering the challenging industry environment post-three FED hikes, along with the macroeconomic headwinds, seemingly better than rest of the industry. As per its latest earnings announcement sent via the bourse, Pakistan Tobacco Company (PSX: PAKT) closed the first quarter ended March 31, 2023 with double-digit growth in its sales as well as its net profits when compared with the same period last year. The growth momentum continues.

PAKT’s gross turnover growth of 11 percent year-on-year to Rs58.7 billion during 1QCY23 owes mainly to the 11 percent increase in domestic turnover (which is 98% of the gross turnover). Considering how the industry-wide output data point towards continued decline in cigarette manufacturing in recent months, the topline gains are likely driven by the increase in retail price of smokes. Meanwhile, PAKT’s export sales also grew by 8 percent year-on-year, accounting for just over 2 percent of the topline.

As growth in FED lagged the gross turnover growth, those gains were reflected in out-of-proportion, 15 percent, increase in net turnover at Rs22.58 billion. The less-than-proportionate increase in FED relative to gross turnover suggests that most of PAKT’s sales growth occurred in the value/affordable pricing tier, which has lower FED rate per cigarette compared to the premium/top tier. Hence, during 1QCY23, PAKT’s net turnover equated 38.5 percent of gross turnover, 119 basis points higher than in 1QCY22.

The declining volumes were evident in the ‘cost of sales’ going down by 8 percent year-on-year to Rs9.63 billion. Perhaps the decrease in these costs would have been higher if it were not for the rising cost of core inputs, fuel, logistics and other services. As a result of the rising topline amid falling cost of sales, the gross profit for PAKT jumped 41 percent year-on-year to reach nearly Rs13 billion in the analysis period.

Due to the impact of higher spending on the selling and distribution expenses as well as a huge spike in the ‘other operating expenses’ (the latter was likely due to foreign-exchange-related losses), the growth in PAKT’s operating profit was comparatively restrained (but still significant) at 32 percent year-on-year, reaching Rs8.68 billion. Down the line, the first-ranked cigarette maker scored some strong gains on account of its ‘finance income’ growing nearly six fold to Rs1.25 billion in the quarter under review, thanks mainly to higher profits on its investments following the successive policy rate hikes.

In the end, despite the impact of booking much higher income-tax expenses (31% of pre-tax profit in 1QCY23 versus 27% in 1QCY22), PAKT closed the three-month period with its net profits rising nearly two-fifth to Rs6.7 billion. At this pace, by the end of this calendar year, the behemoth may surpass its all-time-high profitability of Rs21 billion seen last year. While PAKT has the scale to deal with uncertain market and economic conditions, sustaining higher profitability may require the topline to do better. That may not be an easy feat if there is yet another FED hike in the upcoming budget making cigarettes pricier.