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Philip Morris: Impact Of A Sudden Excise Hike In Asia


Philip Morris International (NYSE:PM) is a global tobacco manufacturer, selling in over 200 countries. Since 2009, the maker of Marlboro has managed to deliver modest increases in revenues in spite of difficult economic situations in some markets, increasing regulatory control over the sale of tobacco products, and currency headwinds. Of its operational regions, Asia happens to be among the most important division for Philip Morris, accounting for close to 35% of our valuation for the stock. Part of this is because Asia is the only region that has actually been seeing increasing market size, which has grown by almost 30% in value between 2009 and 2014. Given this, the region could go on to become a real winner for Philip Morris and go on to bring in almost 37% of the revenues for the company. However, with growing awareness regarding the ill effects of smoking, many Asian countries are resorting to various anti-tobacco measures, mostly in the form of higher excise taxes on cigarettes. Given this, we look at what these changes in tax regimes could mean for future prospects in Philip Morris’ biggest market.

Let’s start by looking at recent changes in tax regimes in key Asian markets such as Indonesia, Japan, Korea, and the Philippines, which collectively account for more than 78% of shipment volume of Philip Morris’ cigarettes.((PMI Fourth Quarter Earnings Results)) The start of 2015 has seen a number of developments on the tax front. For one, Indonesia recently saw a 9% increase in excise on tobacco products, in response to which, Philip Morris hiked cigarette prices by 10%. Korea is expected to see a whopping 120% increase in tobacco excise, in response to which, Philip Morris plans to increase the retail price of key brands, Marlboro and Parliament, by approximately 67%.((PMI Fourth Quarter Earnings Results)) The Philippines has witnessed differential hikes on low and high priced cigarettes, with the former undergoing a 24% increase and the latter a 4% increase. While this is bound to exert a negative impact on market size, by competing in the high price category, Phillip Morris may just enjoy higher market share since the 24% increase on low prices cigarettes might lead to consumers trading up to a high price alternative.((Excise Taxes To Raise Prices Of Cigarettes And Liquor)) Finally, while Japan has resisted tax hikes on cigarettes since 2012, they have been facing continued pressure by the World Health Organization (WHO) to hike excise taxes by close to 50%. In this case, it may only be a matter of time until hikes are put in place even in this market.((Japan Considers Tobacco Tax Increase))

Presently, our forecast for Asia assumes modest increases in excise taxes, which as a percentage of revenues, is expected to increase from about 55% presently to 59% by the end of the forecast period. Given this, revenues in the region are expected to increase at a rate of about 2.5-3.5% going forward. Now, suppose implementation of higher taxes simultaneously in different Asian countries results in a 40% increase, so that excise taxes increase from about $10 billion presently to $14 billion.

Now, what impact could such tax hikes have for Philip Morris’ business?

In the face of increasing taxes, tobacco manufacturers are bound to increase prices in order to maintain revenues and profits. Suppose Philip Morris institutes a one time increase of 20% in response to the higher taxes, and progressively builds on it going forward such that the price per cigarette reaches 10 cents by the end of the forecast period, which is an approximate 50% increase from its current levels. On the demand side of things, higher prices could all together dissuade or reduce usage among existing consumers, and prevent former consumers from using again. Some may choose to trade down to cheaper alternatives, such as brands in the low price segment, or even roll-your-own or make-your-own cigarette offerings, which could adversely impact profitability. Furthermore, consumers may also look at acquiring products through illicit means, which could potentially reduce both, the market size and market share for Philip Morris. Higher taxes could also dissuade consumption among new users, especially in the “adult smokers under 30 (ASU30),” who in general are more vulnerable to pricing.

According to a report by the World Health Organization, the price elasticity of cigarette demand stands at -0.4 for high income countries and between -0.2 and -0.8 for low income countries. Furthermore, this estimate is almost two to three times higher among the youth, in comparison to adults. We assume a -0.6 price elasticity for Asia, i.e. a 10% increase in cigarette prices should result in a 6% fall in demand. Hence, a 50% increase in price should result in an approximate 30% fall in demand, pulling down the cigarette market volume in the region to about 800 billion, from over a trillion presently. While price hikes may be one way of offsetting losses from a declining market, Philip Morris may be constrained beyond a point, since further increases in prices could lead to lower market shares and exacerbate the falling market size. Given this, in the long run the increase in excise taxes, along with falling volumes, may outweigh revenue gains from higher prices, to result in an 11% downside to our current price estimate.

See our complete analysis for Philip Morris in the scenario of the impact of excise hikes in Asia.

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