Foreign competition is depressing the UK tobacco market as companies battle high taxes and an increa...
Foreign competition is depressing the UK tobacco market as companies battle high taxes and an increase in smuggling.
The UK tobacco market is declining by 10% a year, but the number of smokers is not declining at the same rate, says Rupert Welchman, Pan European tobacco analyst at Threadneedle. The reason is that 15-20% of the tobacco sold in the UK is smuggled in and a large proportion of consumers buy from the foreign market.
He adds: "So while the legal market is on a downturn, the illegal and foreign market is on the upswing."
Gerard Callahan, fund manager at Baillie Gifford, points out that 80% of the retail costs of cigarettes goes to tax, so people are buying overseas.
Like Welchman, he believes that a high percentage of the market is smuggled and says there are estimations that if it were organised it would be a £3bn market. Due to this, the tobacco market is heavily distorted and it is difficult to identify trends, he says.
Imperial, which produces the popular brand Lambert & Butler, and Gallaher, which produces the slightly higher-class cigarettes such as Silk Cut and Benson & Hedges, make up 40% of the market share in the UK.
Due to the high share the two have in the UK, entry for other manufacturers is limited, Callahan says. "There is a duopoly and despite the decline the market is still growing modestly," he says.
He estimates this growth to be 5% pa but says this is difficult to forecast as the market is so distorted with 90% of the 20% that is exported by these companies, re-entering the UK illegally.
The Government quandary is how to stop both these issues. One answer would be to cut tax in the UK to combat the foreign market, but this is difficult to do as it may give a backlash as it is seen as unethical, Welchman says.
Sweden did it at one point and completely dissolved the illegal import market. Welchman explains that the economic rationale for tax cutting is that they will make more from the rise in sales than from the higher tax. There is a loud lobby from tobacco companies for the Government to cut tax.
The UK is hit more by places like France and Spain being significantly cheaper than it is by litigation, which depressed the market before the upturn in April, he says.
Threadneedle holds both Imperial and Gallaher, which it says has benefited from recent acquisitions. Imperial recently acquired Rothmans BAT and is the most efficient producer. Imperial's share price is currently 620p and the price range over the year has been between 750p and around 350p.
Gallaher recently bought Liggett-Ducat, a large tobacco player in Russia, and has caught up with Imperial by downsizing.
The risk in the tobacco market lies in the share prices rather than the actual businesses and issues such as litigation have a significant influence.
Callahan adds: "It is important to acknowledge that there is a large difference between the amount of litigation in the US and the UK."
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