How Is Philip Morris Doing In Russia?

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Russia is an important market for cigarette companies. The cigarette market in Russia is estimated to be worth $20 billion. [1] About 40% of the population there smokes, and the average smoker there smokes around 2700 cigarettes a year. Unlike the U.S., where the average smoker used to be at these levels in 1990, the market for cigarettes in Russia is shrinking much at a much slower pace. [2] Russian leaders have also decided to significantly lower import duties on cigarettes by the year 2017. [3] We have written earlier on the regulatory challenges faced by Philip Morris (NYSE: PM) in Russia.(See Philip Morris Earnings Preview) In this article we review some of those regulatory hurdles and take stock of Philip Morris’ current standing in Russia.

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Review Of Regulatory Challenges For Tobacco Majors In Russia

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Last year, Philip Morris’ sales volume in Russia declined by almost 7% as a result of the implementation of excise tax hikes and other anti-tobacco measures. Specific excise tax on cigarettes was increased by more than 40% y-o-y last year. Apart from this, a new anti-tobacco bill that was signed into law on February 25, 2013, also came into effect on June 1, 2013. This anti-tobacco law aims to reduce annual smoking-related casualties in Russia by half over a decade by restricting smoking in public areas and the marketing and sale of cigarettes. It also includes provisions for implementing a minimum price on cigarettes starting 2014 and banning tobacco sales at street kiosks.

As a result of these measures, the size of the cigarette market in Russia is estimated to have further decreased by 8.5% in the first half of 2014. Philip Morris has also increased the price of its cigarette packs by four Rubles a pack across its portfolio. Accounting for reduced consumption due to this price increase, it expects the market size reduction for the year 2014 to be in the 9-11% range. The silver lining  for the company is that its market share has increased across all price categories. Its overall market share increased by 0.9 percentage points over the first quarter to end at 26.8% in the second quarter.

Morris’ Strategic Investment Bears Fruit

In the face of the decreasing demand for cigarettes, the market leaders in the industry had chosen to try a bit of forward vertical integration. Philip Morris and its rival Japan Tobacco had each picked up a 20% stake in the large Russian cigarette distributor Megapolis in December 2013. Japan Tobacco, with its signature brand Winston, has a 36% share of the Russian cigarette market, roughly 10 percentage points more than Philip Morris. It also has four factories in Russia, as opposed to Philip Morris’ two.

Megapolis has a near monopoly on the Russian branded cigarette market, having delivered 260 billion cigarettes in 2012. Its also the exclusive distributor for Japan Tobacco, Philip Morris and Imperial Tobacco in Russia. The investment in its major distributor could have had a hand to play in Philip Morris enhancing its market share last quarter. Philip Morris had agreed to pay up to an additional $100 million based on Megapolis’ performance in increasing sales. [1]

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Notes:
  1. Philip Morris, Japan Tobacco Spend $1.5 Billion On Russian Distributor [] []
  2. Foreign Risks Light Up For Philip Morris []
  3. Philip Morris To Buy Russian Stake []