Rumours & Uncertainty for Big Tobacco

Rumours are swirling that the Queen will announce in May an initiative to curb tobacco use that will include plain packaging

Thomas Mullarkey, CFA 7 March, 2013 | 9:00AM
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Shares of Imperial Tobacco (IMT) were down nearly 2.5% on Wednesday, March 6, following a story in the Guardian suggesting that the Queen will announce in May an initiative to curb tobacco use that will include plain packaging, and a ban on smoking in cars carrying anyone under the age of 16.

Any sudden decrease in cigarette use in the UK will disproportionately impact Imperial Tobacco

We note that any sudden decrease in cigarette use in the UK will disproportionately impact Imperial Tobacco, which holds 45% market share of the country's cigarette market, and 47% share in the fine cut market, and derives roughly 21% of its operating profit from the country.

However, since the plan has yet to be announced, we are maintaining our fair value estimates on Imperial Tobacco (2,400p per share), Philip Morris International (PM) ($95 per share), and British American Tobacco (BATS(3,300p per share).

Additionally, should any restrictions be implemented, we wouldn't be surprised if the tobacco companies file lawsuits claiming that their property (trademarks and brands) were usurped.

We continue to believe that Philip Morris International maintains the best overall global footprint and trades at the most attractive valuation of any of the major international cigarette companies in our coverage universe.

UK lawmakers will likely look to duplicate what occurred in Australia in fourth-quarter 2012 when plain packaging became the law of the land. Each pack now has to display a graphic health warning and utilise a uniform font and green colour. Despite the major tobacco companies filing lawsuits in various international courts claiming that their property (brands and trademarks) were taken without compensation, during the first several months there has appeared to be no meaningful reduction in the quantity of cigarettes consumed in Australia, nor any significant changes in market share.

Despite this, we believe that tobacco makers are concerned that longer-term harm could be done to their business by (1) the increased prevalence of black market cigarettes, (2) an eventual more-rapid decline in smoking rates, and (3) a shift to lower-margin value brands.

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Thomas Mullarkey, CFA  is an equity analyst at Morningstar.