http://seekingalpha.com/article/3592586-philip-morris-reading-the-smoke-signals-in-2015-part-1
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Summary
Roughly one year after my series on international tobacco, I have decided to write an update.
I will focus primarily on the performance of Philip Morris versus its three largest international competitors.
In the first part of the 2015 series, I will study the competitive dynamics in Western Europe.
Due to popular demand, I have decided to write another installment of my 2014-published series on international tobacco called ‘Reading the Smoke Signals’. As customary, I will focus mostly on the international arena (excluding the U.S. and China), because this is the primary battleground for Philip Morris (NYSE:PM) and its largest competitors: British American Tobacco (NYSEMKT:BTI), Japan Tobacco (OTCPK:JAPAY) and Imperial Tobacco (OTCQX:ITYBY). This article will focus on the relative performances delivered by these four companies in some of the different geographic areas in which they compete. I will also look at some of the important structural developments, including the increased pace of consolidation seen year to date. Since Philip Morris is the international market share leader, this company in particular is the focus of the article. In this first installment, I will take a look at the competitive landscape in Western Europe.
Philip Morris in Western Europe
Western Europe is a mature cigarette market with high average prices as a result of high excise tax levels. It also has an increasingly strict regulatory environment with more regulation in sight, as the new EU tobacco products directive is mandated for adoption by EU member states in the spring of 2016 at the latest. Profitability in this region is above average as a result of high average income levels and high average tobacco prices at retail. Philip Morris is the undisputed share leader in the region, due in important part to Marlboro’s long-time leadership and continued resilience. The new Marlboro 2.0 architecture appears to have benefited the brand’s consumer perception and its market share has continuously showed improvements over the past 4 years or so. Marlboro market share in the region was up to 19.3% for 2014 and has increased further to 19.4% as of September 2015. That is an important indication of PM’s ability to keep the brand relevant despite its reliance in part on an aging demographic.
The pace of volume declines in the EU market overall accelerated during the economic crisis in 2008. Next to economic reasons like pressure on personal incomes and high unemployment rates, other important factors contributing to this pressure have been increasing tax rates, an increased prevalence of illicit trade, e-cigarette consumption and increasing regulation because of health concerns. In 2014, however, the industry saw significant moderation in volume declines as a result of the decreased popularity of e-cigarettes, a decrease in illicit trade and some economic improvements as well.
Market share for Philip Morris in the region was up to 39.8% for 2014 and to 39.9% as of September 2015. Next to Marlboro, PM relies on brands like L&M (up 0.1pp to 7.1% share) and Chesterfield (up 0.3pp to 5.8% share) as its most important volume drivers. In markets like Italy and the Czech Republic, it also has ownership of local brands like Diana and Red & White, respectively, that have generally witnessed declines as consumers gradually move to international brands. Philip Morris’s performance has been strong in recent years, as it continues to gain share in many of the region’s most important markets. Its market shares were up during 2014 in all of the following markets: France (up 0.8pp to 41%), Germany (up 0.4pp to 36.6%), Italy (up 1.8pp to 54.9%), Poland (up 1.9pp to 40.1%) and Spain (up 0.9pp to 32.1%). Marlboro’s performance was strong primarily in France and Spain, while L&M drove performance in Poland and Germany. Improvements in Italy were driven by share gains delivered by Chesterfield, which continued to derive benefits from its price repositioning in this market. Market share improvements were reflected in PM’s overall volume improvement of +0.1% during 2014, while the total cigarette market was lower by -3.1%.
The trends seen during 2014 have largely continued during the recently reported 9M period of 2015, with further share improvements seen in France, Germany and Spain. In Italy, the positive performance of 2014 was reversed due to share declines seen in Marlboro as a result of price increases (from €5 to €5.20 a pack), with weakness in brand Philip Morris as well (which includes the morphed local brand Diana), as a result of increased competition in the low-price segment.
British American Tobacco in Western Europe
British American Tobacco has been locked into a battle for the No. 2 share position in Western Europe with Japan Tobacco for a number of years now. BAT appears to be losing this battle when looking at current data. British American’s volume in the Western European segment was down by -5.88% to roughly 112 billion sticks during 2014, while Japan Tobacco’s volume was up slightly by 0.09% to 111.4 billion sticks (for comparison: PM’s was 185.2 billion). In 2014, BAT performed well in markets like France, the Benelux, the U.K., Spain and Poland. Weaker performances were delivered in markets like Italy, Denmark, Switzerland and Germany. Weakness seen in Italy during 2014 appears to have improved notably during the first half of 2015, although the company’s reporting does not really allow for great market share insights.
BAT’s Rothmans brand continues to amaze in terms of volume improvements and added 10 billion sticks during 2014 to its 2013 volume of 26 billion sticks globally (roughly +38.5%). This brand’s strong growth benefits BAT’s European performance in certain markets as well. Italy is one of the markets, where the company is deriving benefits from the performance of this brand, which was up to 4.1% share of market in H1-2015, up from 0.2% in H1-2013 and 2.4% in H1-2014. Rothmans is probably the fastest growing cigarette brand globally (out of those with notable size of course) as a result of its roll-out into new markets and the strong performance of innovations like convertible cigarettes. BAT’s share in Italy stabilized at 20.2% for H1 of 2015 as a result of the performance displayed by Rothmans in this market.
Romania continues to be a BAT stronghold with total share up to roughly 54% in Aug-2015 versus 53.8% during 2013, largely as a result of higher share for Global Drive Brands (GDB) like Kent, Dunhill and Pall Mall. Pressure on BAT’s German share of market during 2014 seems to have been reversed during H1 of 2015, with important brands like Pall Mall and Lucky Strike bouncing back and rising above their shares of last year. This development pushed BAT’s share back up to 19.5% (June 2015) versus 19.4% for the same period last year. In France, BAT’s share has been on the rise thanks to strength displayed by Lucky Strike, with that brand’s share up a full share point to 8.3% in July 2015 and total BAT share up to 17.6% in the same month (17% during 2014).
The most important development in the area of European tobacco M&A was conducted by British American, when it acquired TDR a couple of months ago. The acquisition price totaled €550 million including debt, roughly 12.5x EBITDA of €44 million (2014), which is broadly in line with historic tobacco buy-out multiples. It is not a particularly large acquisition and I am not very familiar with the business in question. TDR apparently has a leading market position in the Balkan country of Croatia (once part of Yugoslavia) and a relevant presence in the neighboring countries Bosnia and Serbia. I expect BAT will use the acquisition, which includes a manufacturing facility in Croatia, as a platform to further develop its business and brands in Central Europe.
Japan Tobacco in Western Europe
Japan Tobacco saw broad-based market share gains in many Western European markets during 2014 with important markets like France up to 20.8% share (+0.8ppt) and Spain to 21.7% (+0.7ppt), largely driven by strengths seen in brands like Winston and Camel. The good performances delivered in these markets were continued during H1-2015 with France up to 21.1% and Spain up to 22%. Market share in Poland improved further as well and was up to 16.4% during H1-2015. Other good performances were delivered in the Czech Republic, Hungary, Germany, the Benelux countries, Greece, Ireland, Poland and Switzerland.
Performance in Italy apparently was less favorable, which continued during H1-2015 because market share dipped to 20% during that period, even though the company’s newly launched Benson & Hedges value offering saw good growth. Austria was a weak performer as well as market share dropped to 32% (down 0.2ppt), with further declines to 31.4% during H1-2015. In the U.K., the company continued to show resilience by widening its leading position, with Amber Leaf further consolidated as the No. 1 fine-cut brand in this market, Sterling is still No.1 in cigarettes and total company share up to 41.6% as of June 2015. I consider the performance of JT in the U.K., especially admirable because it is being achieved largely through the continued strength of local brands, thereby defying the negative growth seen in national brands in most other cigarette markets. In the U.K., the tobacco market is largely divided between Imperial Tobacco and Japan Tobacco, with share gains made by Philip Morris and BAT apparently primarily at the expense of Imperial Tobacco.
In Romania, JT also continues to perform well with its share of market up to 25.2% due to strength in Winston, Sobranie and Benson & Hedges. It has a decent No. 2 position in this market after BAT, which has roughly half the market.
Imperial Tobacco in Western Europe
Imperial Tobacco meanwhile relies to an important degree on core markets like France, Germany, Spain and the U.K. for a large part of its European volumes. This company is extremely reluctant with providing data on market share performance, which I attribute to their largely unfavorable track record on this metric. I believe the company lost market share in all four of its core European markets, which is due at least in part to their inferior brand portfolio which contains mostly local brands. Their historic strength in fine-cut tobacco has also been less advantageous than one might expect to be the case in austerity-stricken Europe, because the other companies have leveraged their cigarette brands to launch fine-cut offerings as well.
Imperial Tobacco has been actively trying to gain share of the Italian market with its John Player Special brand, which I believe is the factor primarily responsible for the changed dynamics in the lower-priced segment of this market. Imperial gained share in Italy during 2014 from a modest level. This positive momentum was continued during H1 of 2015 with premium brand Davidoff also doing well. Other gains were delivered in Greece, the Nordics (in snus tobacco), Portugal and the Czech Republic. Share declines were registered in markets like the Benelux and Germany (in fine cut), with share developments apparently stabilizing in Austria. The developments in Imperial’s most important European markets largely continued in the same direction during 2015. The Benelux countries, which are also important fine-cut markets for Imperial, apparently showed more stabilized share performances.
Market share was reportedly down in the U.K. during H1-2015. Interestingly, the company reports having a ‘leading position’ in the U.K., but in my opinion they now trail Japan Tobacco in this market.
The U.K. is one of the most important European markets for Imperial Tobacco, because it has long held a significant market share there, although this position has been eroded somewhat by PM and BAT gaining share with Marlboro and Rothmans, respectively.
IMT does not provide extensive volume numbers either, but its global volume was down strongly during its fiscal year 2014, namely by -7.26% to 294 billion sticks. This was due in part to an inventory realignment program that ended during the year, as could be seen by the moderation in its reported decline to -2.77% for 9M-2015 (the underlying decline was -6% though). I strongly expect this company’s organic growth will continue to underperform its international peers, although it has in the past year benefited from its lower-than-average exposure to emerging market currencies and the brand acquisition in the US.
Conclusion
Philip Morris and Japan Tobacco continued to outperform in the Western Europe region during 2014 and H1-2015, with British American and Imperial showing significant weakness during FY 2015, but apparently showing some improvements during H1-2015. Since PM, BAT and JT have all reported significant gains in important markets like Germany, France, Spain and the U.K. over the past years, I strongly suspect Imperial Tobacco is losing ground rather quickly in these countries.
Imperial Tobacco is a company that has conducted a lot of acquisitions during the past two decades or so; its significant presence in France and Spain is the result of its 2008 acquisition of Altadis (which was created out of those two countries’ former state tobacco monopolies). It, therefore, relies extensively on local brands in these markets, which are very consistently being outcompeted by the international brands owned by PM, BAT and JT. In Germany, Imperial Tobacco also has a strong presence as a result of its 2002 acquisition of Reemtsma, which includes a strong presence in the fine-cut tobacco category. This is a very large segment of the German tobacco market overall, which should have served Imperial well since it is a fine-cut specialist, but the other companies have successfully taken share in this category as well. In my opinion, therefore, Philip Morris and Japan Tobacco have shown themselves to be the best operators in Western Europe.
In the upcoming Part 2 of my ‘Reading the Smoke Signals 2015′ series, I will take a look at the performance of the international tobacco companies in another geographic region, so keep an eye out!
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