Over the last few years there has been a push by governments across the globe to severely restrict the type of cigarette packaging allowed.
Australia has had a plain packaging law in effect since Dec. 1, 2012, and Canada has required graphic warnings covering 75% of the package since 2011. France and the U.K. will likely move to plain packaging sometime in 2017, and there are pushes for plain packaging laws in Ireland, India, Malaysia and New Zealand.
The cigarette industry has always faced severe restrictions on advertising, and packaging was one of the few avenues it had left to build and maintain brand identities. Do investors in the big four international tobacco companies –Â Philip Morris International (PM, Financial), British American Tobacco (BTI, Financial), Imperial Brands (IMBBY, Financial) and Japan Tobacco (JAPAY, Financial)Â – need to fear the effects of the plain packaging regulatory wave or will cigarette companies be saved by the addictive nature of their products?
Does plain packaging work?
There are mixed messages about the effectiveness of plain packaging laws. The tobacco companies, of course, claim that plain packaging laws encourage illicit cigarette use and don’t have any effect on smoking rates. The countries enacting the laws claim the opposite. Since only two countries have enacted plain packaging laws, there is not a lot of data as to whether they work as intended, and there is certainly a conflict of interest with tobacco companies highly incentivized to show the laws as ineffective and for countries to claim they work.
Australia’s plain packaging law seems to be reducing smoking rates more than would have been expected without the law. It may not even matter; countries have little to lose by enacting plain packaging laws and a lot to gain through lower health care costs because of lower smoking rates.
It makes perfect sense for every country to attempt to enact a plain packaging law as a low cost way to save on health care costs. Because of this there will be an inevitable push over the next decade toward enacting plain packaging with the European Union leading the way followed by other developing nations.
The question then is how much this will affect the international tobacco companies. We already know that smoking rates are declining, but will plain packing rates push the declines past the point where the tobacco companies can offset them with price increases to maintain profits?
Because there is not a lot of hard data to go on, we combed through several years worth of annual reports for tobacco companies that did significant business in the two countries that enacted strict packaging restrictions on cigarettes.
Australian case study
On Dec. 1, 2012 Australia enacted its plain packaging law. We looked at what British American Tobacco and Imperial Brands Group said about their business after the plain packaging law was put in place. Unfortunately the companies do not disclose exact sales figures by country in their annual reports.
For fiscal year 2013 British American Tobacco had this to say: “Profit was up strongly as a result of higher pricing and cost-saving initiatives, partially offset by lower volume. Illicit trade increased following the introduction of plain packaging. Market share was lower.”
For fiscal year 2014 the company said, “Volume was impacted by market contraction and higher illicit trade. A challenging pricing environment led to lower profit. Share was lower due to down trading.”
For fiscal year 2015 the company said, “Volume fell due to market contraction. Excise-led price increases, a challenging environment and continued high prevalence of illicit trade led to down trading and a significant reduction in profit. Market share was flat.”
Imperial Brands' summary for fiscal year 2013 was “In Australia we were well prepared for the introduction of plain packaging last December and have continued to grow our business in this restrictive environment. Revenue and profit were up as were both our cigarette and fine cut tobacco shares. This reflects our total tobacco expertise and another outstanding performance from JPS.”
For fiscal year 2014 Imperial said, “We grew volumes, revenue and profit and increased both our cigarette and fine cut tobacco shares with JPS.” For fiscal year 2015 Imperial said, “Another excellent performance from JPS, now the leading brand in the market, resulted in further revenue, profit and share growth.”
Canadian case study
In 2011 Canada forced cigarette manufacturers to place a graphic warning covering 75% of a pack. While not plain packaging it is very similar as it reduces the tobacco companies' ability to brand their products to allow them to stand out.
Here’s what British American Tobacco said throughout its annual reports about the Canadian market.
In fiscal year 2012: “Volumes and market share increased, consolidating leadership in each of the segments. The company was the only one to increase market share. Profit was stable. Illicit trade was flat.”
In fiscal year 2013: “Profit grew, benefiting from the stronger performance in the premium segment, price increases and a lower cost base. Volume and market share were lower.”
In fiscal year 2014: “Increases in federal and provincial excise led to lower volume. This was more than offset by higher pricing which led to increased profit.”
And finally in fiscal year 2015: “Profit grew strongly driven by good pricing and cost reductions, offsetting lower volume. Market share fell despite growth in Pall Mall.”
Summary
In Australia we see that British American began to lose market share as consumers traded down to the lower-priced brands, particularly JPS, owned by Imperial. We can see that the quotes from BTI’s annual report continually blame plain packaging laws and show steady market share erosion.
In contrast Imperial’s lower-priced brands gained at the expense of British American’s brands. In Canada the story is less clear. Based on the excerpts from British American’s report there seems to be little effect due to the more restrictive packaging laws. In Canada British American seems to be seeing the usual combination of a slow decline in smoking rates coupled with offsetting price increases.
While we only have the results from two countries to go on it seems that as long as tobacco packaging has at least some area for a company to keep its logo there will be little effect on sales.
Completely plain packaging seems to moves sales from higher- to lower-priced brands. As the international tobacco market slowly grinds its way toward more restrictive packaging it appears that cheaper down market brands will benefit at the expense of the premium brands. It still remains to be seen if plain packaging will materially alter the lower volume/higher prices business model of the tobacco companies.
There is also the case of brand differences across countries. What might be a premium brand in one market could be a value brand in another; for example John Player Specials isa value brand in Australia while it is more of a midmarket brand in the U.K.
If you are thinking about investing in international tobacco companies, it may be easiest to simply buy a basket of all four rather than trying to determine which company possesses the best combination of low-priced brands in all of the countries likely to implement plain packaging laws.
Disclosure: Long PM, BTI, IMBBY.
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