Russian lawmakers have approved an anti-smoking bill that will impose restrictions on tobacco advertising, kiosk sales for cigarettes and will phase out smoking in public areas like bars, restaurants and educational institutions by 2015.  Interestingly, Russia’s population is just around 10% of China, but it is the world’s second largest tobacco market after China. Hence, the law is bad news for international tobacco companies like Philip Morris International Inc. (NYSE:PM), British American Tobacco Plc (BATS:LSE), Japan Tobacco Inc. (2914:Tokyo) and Imperial Tobacco Group Plc (IMT:LSE).
According to data compiled by World Lung Foundation and American Cancer Society, Russia has an exceptionally high smoking rate and is placed fourth in the list of countries with a large smoking population.  For the first nine months of 2012, the Eastern Europe, Middle East and Africa (EEMA) region contributed almost 25% in net revenues for Philip Morris. Russia alone contributed around 6% to the company and is of huge importance to Philip Morris.
Here we assess the impact of implementation of this anti-smoking legislation in Russia on the company.
- Philip Morris Misses Q1 Revenue And EPS Estimates
- Will Philip Morris Beat Expectations This Earnings Season?
- How Did Philip Morris Perform In The European Union, And Its Key Markets There, In 2015?
- How Did Philip Morris Perform In Russia, Given The Currency Headwinds And Excise Tax Rise?
- How Has Philip Morris Fared In Comparison To Its Peers?
- How Has Philip Morris’ Shipment Volume, By Brand, Changed Over The Past 3 Years?
About the Russian Anti-Smoking Law
The initial draft of the bill proposed measures that would outlaw all tobacco advertising and sponsorship as well as kiosk sales of cigarettes immediately. It also suggested ban on cigarette trade in small retail outlets and smoking in public places, taking effect January 1, 2015. However, the approved second draft was tweaked to drop restrictions on cigarette sales in retail outlets, except for kiosks and the right to set minimum cigarette prices. Also the ban on public smoking will take effect from mid-2014, six months earlier than the initial deadline of January 2015. The law must go through a final reading in both the lower and upper houses before being signed by President Vladimir Putin.
Impact on Philip Morris International
Based on impacts of similar laws in the U.K., the impact of ban on public smoking should be positive in terms of reduced health implications of passive smoking.  Also, smoking rates may decline due to increased restrictions imposed under the law, on smoking environments. However this is expected to negatively impact the cigarette consumption volume in the country and hence Philip Morris.
The move to restrict advertising and sponsorship can impact the opportunities of brand equity building. However, this can also be seen positively by established brands as it reduces the ability for newer brands to become popular, hence reducing competition in the market. F0rtunately, Philip Morris operates some of the best performing brands in the market, like Bond Street, and Chesterfield, and controls more than 25% market share. Hence there should be limited negative impact of restricted marketing on its market share.
The restriction on sales of cigarettes from kiosk outlets is aimed at limiting underage consumption of cigarettes since these outlets are not easily monitored as compared to retail traders and super markets. However, its impact on the decline in cigarette volume is expected to be limited due to the fact that it would not severely impact the availability of these products. The impact would have been substantial if the restrictions on sale of cigarettes in retail stores would not have been dropped.
There is evidence that the largest factor leading to a decline in cigarette volume in developed nations has been hikes in excise duties. Hence, what is expected to bring down the smoking rates and subsequently cigarette sales volume drastically in Russia, is the proposed hikes in excise duties. The Russian Finance Ministry has planned an increase in excise duties on tobacco by around 40% in 2013 and 2014, followed by a 10% hike in 2015, while the health ministry is pushing for an even higher hike in excise duties. These duties are expected to lead to sharp increase in cigarette prices, which would negatively impact demand substantially.
Overall, we have factored in a declining trend in the EEMA region cigarette sale volume of around -0.5% CAGR. If the law was to be implemented successfully as proposed, there could be an accelerated decline in cigarette volume in the region.
If the rate of decline in cigarette volume in the EEMA region were to be around -10% over the forecast period, it would imply a near 15% downside to our current price estimate for Philip Morris. Notes:
- Russian parliament Backs Anti-Smoking Bill in Key Ruling, January 2013, Bloomberg [↩]
- Who Smokes Most: A surprising map of smoking rates by country, October 2012, The Washington Post [↩]
- Smoking ban’s impact five years on, June 2012, BBC [↩]
- Russian anti-smoking bill backed by lawmakers, January 25, 2013, Reuters [↩]