Weekly Tobacco Notes: Uruguay Responds, China Clamps Down

Tobacco has always been subject to Government regulations regarding the quantity and quality of production. The debate regarding the appropriate extent of regulation of tobacco has also been ongoing. ^[1] In our weekly note on the tobacco industry, we take a look at two regulatory challenges to the business of Philip Morris International (NYSE: PM). The first of these relates to Uruguay’s defense of its regulation regarding the health warnings on cigarette packs (see Philip Morris’ Uruguayan Lawsuit). In the second instance, China is contemplating a ban on tobacco advertising and smoking in public places. ^[2]

We have a price estimate of $79 for Philip Morris, nearly 10% below the market price. We have a revenue net of excise estimate of $30 billion for the company. This is roughly the same as the Reuters analyst consensus estimate. ^[3] 

See Our Complete Analysis For Philip Morris International

Uruguay Strikes Back

Uruguay filed its defense against Philip Morris in a $25 million case PMI filed with the World Bank’s International Centre for the Settlement of Investment Disputes (ICSID). The country justified its 2009 regulation that requires tobacco companies to cover 80% of the area of cigarette packets with graphic health warnings, and prevents them from adding labels such as light and low-tar to cigarette names. The main aspect of the country’s defense is rumored to be the impact such regulations have had on smoking among Uruguayans. In 2009, when the legislation was enacted, 32% of the country’s population smoked. Now it is down to 23%. The government is also arguing that it is bound by an international agreement to take steps to reduce the prevalence of smoking. ^[4]

We have written earlier about the support extended to Uruguay by various health organizations (See Earlier Weekly Tobacco Notes). The director of one such health organization, the Pan American Health Organization/World Health Organization (PAHO/WHO), congratulated the Uruguayan Government on resisting the intimidation tactic that the lawsuit is seen by some to represent. She went on to describe Uruguay as a role model for the world. Philip Morris, on the other hand, received rebuke from the Director-General of the World Health Organization (WHO), who described its lawsuit as an example of the tobacco industry’s devious practices. ^[5]

There have also been allegations that Philip Morris is trying to make an example of Uruguay through this lawsuit, which we have earlier written about as having international implications (See Philip Morris’ Uruguayan Lawsuit). New Zealand, for instance, is holding back on its similar effort at regulating the cigarette industry pending the outcome of the lawsuit. However, there has also been an international development that bodes well for the Uruguayan Government. Australia’s high court recently held up the Australian Government’s plain packaging policy and excise tax increases that ran PMI out of Australia. ^[6] Philip Morris shifted its production catering to the Australian market to South Korea in the face of declining demand in Australia, ostensibly as a result of the Government’s crackdown on the tobacco industry (see Our Third Quarter Earnings Coverage Of Philip Morris).

China Mulling A Similar Ban

This week also saw news that the Chinese Government is considering restrictions on tobacco advertisements and public smoking. This is important for the tobacco industry, as China is a large market. ^[7] It has nearly a third of the world’s smokers, who smoke 40% of the world’s cigarettes. ^[8] In 2013, China’s tobacco industry generated roughly $156 billion in profit before tax. ^[2] However, 98% of this market is currently in the hands of the government-owned China National Tobacco Company (CNTC). Philip Morris has a licensing agreement with it, which lets CNTC market Marlboro cigarettes in China. ^[9] This has given it a measly 0.3% market share in the country. ^[8]

Given the low market share, Philip Morris will probably not be concerned about the reduction in sales on account of such a policy. However, there are two other ways in which such a ban would hurt the company. For one, it adds one more to the list of nations seeking to rein in tobacco consumption with a view to improve public health. Secondly, it could reduce the domestic demand in China, prompting CNTC to export more. CNTC has historically exported a very small percentage of its production. In 2010, this figure was only 1%. ^[10] A study done by the Harvard School of Public Health opines that CNTC is likely to become a multinational brand going ahead. ^[11] Having a large inventory of unsold products may force this internationalization upon it sooner. This could erode Philip Morris revenues and/or margins in Asia should CNTC be prompted to compete with it in the lucrative cigarette markets of Asia outside China.

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1. History Of Tobacco Regulation [↩]
2. China Considers Ban [↩] [↩]
3. Reuters PM Financial’s Page [↩]
4. Philip Morris Lawsuit Against Uruguay [↩]
5. ref: 5 [↩]
6. Australian High Court Rules Against Big Tobacco [↩]
7. Tobacco In China [↩]
8. Philip Morris’ Final Frontier [↩] [↩]
9. China Moves To Cut Smoking [↩]
10. The Chinese Tobacco Market [↩]
11. The Emergence Of The Global Tobacco Empire [↩]