Weekly Tobacco Note: What Do Massachusetts, Europe and Asia Have In Common?

Last week we wrote articles on the impact of illicit cigarettes on the revenues of the Marlboro brand in three geographies, Massachusetts, Europe and Asia (click on the links for the articles). While in Massachusetts, Altria Group (NYSE: MO) sells Marlboro, Philip Morris International (NYSE: PM) markets the brand in Europe and Asia. In this weekly tobacco note, we summarize our results from these three articles.

Philip Morris lost $2 per share last week in trading as its price went from $88 to $86 a share. We estimate the value of this stock to be $79 per share. We have a revenue net of excise taxes estimate for the company for 2014 of ~$30 billion, in line with the Reuters consensus estimate. ^[1]

Altria Group lost $1 per share in trading last week as it went from $50 to $49 per share. We estimate the value of this stock to be ~$44 per share. We have a revenue net of excise taxes estimate for the company for 2014 of ~$18 billion, in line with the Reuters consensus estimate. ^[2]

See Our Complete Analysis For Philip Morris International | See Our Complete Analysis For Altria

Types Of Illicit Cigarettes

Of the three regions studied, Asia provided the most comprehensive classification of illicit cigarettes. We apply it here to all the three markets under study. Counterfeits have been defined by the researchers as cigarettes that are illegally manufactured and sold without permission of the trademark rights holder. Contrabands are cigarettes bought legally in low excise tax states/countries and smuggled to high excise tax states/countries to be sold below the tax-inclusive market price of these products. Domestic illicits are  manufactured  and sold in the same state/country without paying the excise taxes. Cigarettes that cannot be identified as legal or falling into any of the three categories above are classified as unspecified.

Extent Of Illicit Cigarette Sales

Massachusetts increased its state excise tax on cigarettes from $2.51 per pack to $3.51 in 2013. The Massachusetts Department of Revenue economists have estimated that prior to the raising of taxes, between 7% and 20% of the cigarettes consumed in the state were untaxed. With the tax increase, this figure is expected to go upto between 8.3% and 27.5%. The broad range reflects the uncertainty due to lack of availability of necessary data and unreliable nature of available data. Of the two ways of taking advantage of the higher tax, namely smuggling and counterfeiting, the former has been estimated to be a greater threat in Massachusetts. This is due to the prevalence of lower taxes in neighboring states, which induces smuggling across state borders.

Philip Morris contracted accountancy firm KPMG to conduct a study on their behalf to estimate the size of the illicit cigarette market in Europe. This endeavor, called project star, found that 10% of the cigarettes consumed in the European Union in 2013 were illicit, 33% of which were low priced varieties manufactured exclusively for smuggling. The consumption of these increased 15% year on year to reach 19.6 billion cigarettes. The sales of contraband was estimated at 35.6 billion cigarettes, or 60% of all illicit cigarettes consumed in the EU. The remaining 7% were most likely to be counterfeits.

The International Tax and Investment Center and Oxford Economics was contracted by Philip Morris to study the illegal cigarette market in 14 Asia Pacific region countries. These include the 10 ASEAN member countries, Australia, Hong Kong, Pakistan, and Taiwan. The study found that while people in these countries smoked ~760 billion cigarettes in 2013, 10.9% of these were illicit. In countries excluding Laos, Cambodia and Myanmar, the number of illicit cigarettes increased over 20% year on year. The major contributor to this increase was Philippines, which tripled its illicit cigarette consumption in one year.

Reduction In Legal Cigarette Sales Due To Illicit Cigarettes

Altria’s cigarette sales revenues from Massachusetts is estimated at $750 million. A loss of 3 5% of these revenues is caused by illicit cigarettes as per our calculations. This implies a loss of between $22.5 milion and $ 37.5 million of lost sales for Altria Group in Massachusetts on account of illicit cigarettes.

Philip Morris loses 4% of its Europe revenues to illegal cigarettes. With revenues from Europe for Philip Morris coming in at $28.3 billion in 2013, illicit cigarettes reduced the company’s topline in Europe by $1.13 billion. This is a significant figure even for Philip Morris, since it represents about 1.4% of its global revenues.

Such a loss of revenues to Philip Morris in Asia occurs because of the incidence of counterfeiting, domestic illicits and unspecified illicits. Contrabands are expected to augment company revenues in countries where they are purchased by the smugglers. Of the ~760 billion cigarettes consumed in the Asia Pacific region’s countries under study in 2014, ~83 billion were illicit, of which ~11 billion was contraband. Hence, the tobacco industry lost out on 72 million units worth of sales due to illicit tobacco. This represents 9.5% of total tobacco consumption. Therefore, for every 90.5 dollars earned by the tobacco companies through legal sale of cigarettes, 9.5 dollars was lost to illicit cigarette sellers, an opportunity loss of 10.5%. Given that Philip Morris earned $10.5 billion net of excise taxes from Asia in 2013, it lost out on potential  sales worth ~$1.1 billion in Asia due to the incidence of illicit cigarettes.

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1. PM Overview At Reuters [↩]
2. MO Overview At Reuters [↩]