Wednesday 24 April 2019

No smoke without ire: Big Tobacco gets angry

The Irish market is so profitable for cigarette makers that the largest is willing to sue the Government over packaging rules. We look at why Ireland is such a goldmine for Big Tobacco

Minister James Reilly spearheaded the drive to force tobacco companies to remove all branding from cigarette packs
Minister James Reilly spearheaded the drive to force tobacco companies to remove all branding from cigarette packs

Sarah McCabe

There was outrage this week when it emerged that Japan Tobacco International (JTI) has threatened, via lawyers Arthur Cox, to sue the Irish Government for damages if it does not halt the progress of plain packaging legislation making its way through the Dail.

It seems Big Tobacco is not taking the State's efforts to regulate its product lying down.

The legislation, spearheaded by Minister for Children James Reilly, would force JTI - owner of Silk Cut and B&H - to remove all branding from cigarette packs.

There is a reason JTI Ireland, whose directors include former South Dublin Chamber of Commerce director Gerard Redmond, is willing to make a move as hostile as to threaten the Government with a lawsuit. Tobacco companies make astronomical profits in Ireland, experts told the Sunday Independent.

"Their profit margins are astonishing," said Rob Branston.

Branston is a professor in economics at the University of Bath and authored the only definitive research into the finances of tobacco firms in Ireland, commissioned by the Irish Heart Foundation and the Irish Cancer Society.

He studied the three main players who control nine-tenths of the Irish market. One is British American Tobacco (BAT), which controls about 10pc and makes Dunhill, Lucky Strike and Pall Mall. Its chairman Richard Burrows is the former governor of Bank of Ireland. JTI is the biggest Irish player, with 47pc of the market. The third firm is Imperial, which makes John Player and has a 33pc share.

None publish country-specific financial results, so we have only estimates to rely on.

They generated combined revenue of €226.5m in 2011, Branston found. Their profit on these sales, he calculated, was €104.3m - a 46pc margin. "For most other consumer goods staples, a normal margin is around 20pc," he said.

This figure excludes taxes. Some €7.87 of every €10 packet goes to the State in excise duties and VAT. Ireland places the third highest tax in the EU on a packet of 20 cigarettes, which after last year's Budget hike costs €10. The UK is the second most aggressive taxer, with a pack coming in at €11.33. Norway is first at €11.77.

But more than a fifth of the Irish retail price - €2.13 - still goes to private industry. When your product costs between 30c and 40c to make, says tobacco industry analyst James Bushnell of Exane BNP Paribas, €2.13 still represents exceptional profits.

The fact that prices vary so wildly across Europe supports the idea that it takes a very low amount for this product to be profitable. As of December 2014, a pack of 20 costs €1.56 in Russia; €0.92 in Belarus; €1.03 in Ukraine; €3.40 in Andorra; €4.50 in Portugal; €3.29 in the Czech Republic; and €3.53 in Poland. Bushnell believes profit margins could be even higher than Branston's estimates.

"While most tobacco companies don't release country-specific results, Imperial did for the UK until 2013. In that year it had a 68pc operating margin in Britain - exceptionally high. I would think it enjoys similar margins in Ireland as the markets are highly similar - certainly north of 60pc anyway."

Some say these kinds of profits are on their way out. The number of Irish smokers is clearly on the decline. Figures released by the Health Service Executive this week showed that smokers, as a percentage of the total population aged over 15, had fallen to below 20pc last year, from 28pc in June 2003. The number of Irish smokers dropped by 70,000 last year alone.

But the same trend is evident in mature markets around the world, said Bushnell, and it's not hurting Big Tobacco's bottom line.

"Tobacco companies compensate for falling sales in wealthy economies by introducing small, easy-to-miss price increases, often timed to coincide with increases in excise duties by governments. It is much easier to do this in countries like Ireland, where the overall price of a pack is very high because of taxes. A couple of extra cent is tiny for the consumer when they are already paying €10 a pack, but makes a huge difference for the manufacturer because their costs are so small," he explained.

"Volumes are falling in mature markets around the world. But this has been happening for a long time and tobacco companies' business models incorporate it. In emerging markets, they are less heavily regulated and have far more opportunity to build their customer base through marketing.

"In mature markets, they can introduce small price hikes to offset falling demand because the overall price is already so high that the consumer doesn't notice.

"Globally it is also a very consolidated industry which means price competition is slim."

Also working in Big Tobacco's favour is the elasticity effect - a result of the product's addictive nature. For every 1pc increase in price, the International Agency for Research on Cancer found, demand only falls by 0.4pc. This means price rises more than compensate for the corresponding fall in sales they trigger.

Another major driver of the industry's rude financial health is its lack of change over the decades. Fashion and food tastes have changed dramatically in the past 50 years - but a cigarette still looks, feels and tastes broadly the same, and the brands selling them have evolved very little. The addictive nature of the product and strong customer loyalty enjoyed by its brands mean there is little need for product innovation which helps to keep research and development costs down.

The best gauge of an industry's health is its biggest companies' share prices - and investors do not appear to be worried.

Tobacco is still highly valued as an investment by financial institutions. Last summer, it was reported that several major funds were overleveraged in tobacco stock, generally a sign that portfolio managers believe the stock will outperform other securities.

And while smoking is receding, data suggests that it is still a huge part of the Irish consumer landscape, unlikely to die out anytime soon. The Government enjoyed €1.06bn in tax receipts from tobacco sales in 2013, suggesting the industry is worth around €1.4bn annually. By contrast, the retail coffee market is estimated to reach just €71.7m next year.

What about the spin-off dependants of the tobacco industry - the retailers? Retail body Ibec has weighed in on the side of the tobacco industry in the plain packaging debate.

"We are very concerned at the effect these proposals could have on branding rights by the removal of all forms of branding," it said in a submission to a Joint Oireachtas Committee last February.

But Branston argues that retailers enjoy very little of the spoils of the tobacco industry, estimating they get a cut of 6-7pc.

"Cigarette manufacturers often encourage the retailers to complain when government hikes the price of tobacco, but actually they don't lose very much when cigarette sales fall - many retailers even use tobacco as a loss leader."

Concerns about losing manufacturing jobs by taxing tobacco out of existence are no longer an issue. Ireland's last cigarette factory - a JTI plant in Antrim, formerly owned by the Gallagher tobacco dynasty - has been earmarked for closure.

This is not because manufacturing is being moved to far-flung, cheaper developing countries such as China, according to Bushnell. Tobacco products tend to be manufactured in or near the market where they are sold, he said, to keep transport costs low and avoid vulnerability to currency swings.

That means cigarettes sold in Ireland are generally made in Europe - in the UK, low-cost Poland, France, Germany or Switzerland, which has generous tax breaks for cigarette manufacturers.

The closure of the Antrim facility could be down to the Government's aggressive stance on tobacco industry, he said. "They tend to close factories in countries that are less friendly, where governments are hostile."

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