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Philip Morris and British American Tobacco: Comparative Analysis

Table of Contents

Industry Overview 2
E-Cigarettes: A Threat or an Opportunity for the Tobacco Industry 2
Philip Morris: Company Overview 3
Philip Morris International: Facing The Current Financial Difficulties 4
British American Tobacco: Company Overview 4
British American Tobacco: Negative Image 5
SWAT Analysis: Philip Morris 5
SWAT Analysis: British American Tobacco 8

Industry Overview

Tobacco and cigarette business must be one of the most profitable in the world: in 2010 the combined profits of six leading tobacco companies were $35 billion, which was equal to the profits of such multinational giants as Coca-Cola, Microsoft and McDonald's put all together.
After a number of mergers and acquisitions that took place during the 1990s and 2000s, the global cigarette market is dominated by four multinationals: Philip Morris International, British American Tobacco, Japan Tobacco International and Imperial Tobacco. China National Tobacco Corporation, which holds a near-monopoly in Chinese tobacco market, is the world’s largest cigarette maker.

Despite incredible profitability and high net worth, the general picture of the sector does not look that good: Excluding the sales data from China, the total volume of cigarettes that was sold in 2013 decreased by 4%, continuing the trend that started in 2010.

E-Cigarettes: A Threat or an Opportunity for the Tobacco Industry

E-cigarettes are smoke-free, tobacco-free consumer goods sold as an alternative to traditional cigarettes or a tobacco harm reduction product.
In the past few years, and especially starting from 2013, the sales of e-cigarettes increased dramatically, taking many people in the industry by surprise.
According to the multiple surveys conducted by Action on Smoking and Health (ASH), only in the UK, the number of people who use electronic cigarettes on a regular basis had tripled over the past two years and had reached 2,1 million people.1
A tobacco analyst from Wells Fargo, Bonnie Herzog predicts that the sales of e-cigarettes in the US and Europe will surpass the sales of traditional cigarettes in the next decade.2 The demand for e-cigarettes has increased from a few thousand users in 2006 to several million globally, and now consumers have over 200 brands available in the market. E-cigarette sales were estimated to reach $1,5 billion, and top $10 billion by 2017.

China, the world’s largest producer and consumer of cigarettes, might become the biggest market for e-cigarettes in the nearest future: about 1,2 million people die every year from diseases associated with the tobacco consumption. Even if 1% of the total smokers will decide to switch to e-cigarettes, it would create a market for 3,5 million e-cigarette users.3

The potential of e-cigarettes is to improve public health, deliver nicotine without intoxicating the person who uses it. In the future, it might either work well and become as common as the conventional cigarette, or it could end up as one of the new trends, which do not stay long, and the smokers will continue consuming good old normal tobacco products.

Source: UBS, Wells Fargo, Tobacco Vapor Electronic Cigarette Association
Research Date: February 2nd, 2015

Philip Morris: Company Overview

The history of the company traces back to 1847, when Mr. Philip Morris had opened a single shop on Bond Street in London for selling tobacco and ready-made cigarettes. After his death the business was taken over his wife and his brother, therefore the company continued operation as a family business. In 1881 the company went public and in 1894 it left the control of Morris family. In 1902 it incorporated in New York and the ownership was split 50-50 between the British and American partners.
The year 1919 became a critical point in the history of the company: first Philip Morris logo was introduced, through the acquisition the company was now owned by American shareholders and incorporated in the state of Virginia under the name of Philip Morris & Co., Ltd., Inc. In a few years, the company already had the manufacturing plant in Richmond, and in 1924, Marlboro - today's most popular cigarette brand was introduced.
Philip Morris International sells its products in over 180 countries with 17,4% of the global cigarette market share. It owns seven of the top 15 brands in the world including Marlboro, L&M, Bond Street, Philip Morris, Chesterfield, Virginia Slims, and Benson & Hedges.

Philip Morris International: Facing The Current Financial Difficulties

In the past years, Philip Morris has proven itself as one of the most financially well-managed companies, providing sustainable growth in value for shareholders despite some financial difficulties that company faced in the past two consecutive years. In 2008 PM had reported $63,640 million in net revenue; that number was 15,2% greater then the result of the previous year. PM’s profits were increasing annually until 2012, and starting from 2013 the company's earnings had been declining. In 2012 net revenues reached $77,393 million, and the latest figures for 2013 and 2014 are $80,029 million and $80,110 million respectively. The year 2013 became one of the most challenging in company's history in the terms of revenue, with a negative growth rate of 1.32%. Despite this not very positive tendency, PMI stocks remained attractive for the investors: the recent buybacks, which were flawlessly executed, allowed the company to boost its earnings per share and set a high bar for the future dividend payouts.

British American Tobacco: Company Overview

British American Tobacco had started as the joint venture of a British Imperial Tobacco Company and US American Tobacco Company in 1902. This event was followed by a period of rapid expansion in Europe, as well as in India, Egypt, Indonesia and East Asia.
On of the main factors that contributed to such rapid growth was BAT’s overseas policy: many subsidiaries were run far away from the London’s head office, which allowed the company to operate the growing emerging markets such as China, India and Latin America. By 1981, the annual profits of BAT reached more than £463 million, and by 1999, through a series of acquisitions the company added the well-knows prestigious brands like Lucky Strike, Pall Mall and Dunhill to its portfolio.
Annual revenues in 2013 and 2014 were $23,16 billion (£15,26 billion) and 21,20 billion (£13,97 billion) respectively. BAT has approximately 14.30% of the global tobacco market share, which makes it the second largest publicly listed tobacco company in the world.

British American Tobacco: Negative Image

Throughout the history of the company, BAT is continuously involved in multiple scandals and court cases, some of which give the company a very bad reputation.
In the late 1980’s the competition in the Chinese tobacco market was so intense, that bribes were paid to the local BAT director. Former export director Jerry Lui had faced the charges; during the process of the investigation the main witness against him was murdered, and the murder case was never solved. There were no charges against BAT.

British American Tobacco had recently assigned KPMG as a new auditor, after ending a 17-year long partnership with PwC. BAT had taken PwC to court because of the issue unrelated to auditing: the tobacco giant had taken legal actions trying to avoid being dragged into a scandal with pollution of the Fox River in Wisconsin, US. The potential bill to be paid for environmental damages is $1bn (£651m).

SWAT Analysis: Philip Morris

Strengths
Brands
PMI has a portfolio of very well established brands: for many years Marlboro is the leading cigarette brand in the world and this gives the company a very significant competitive advantage in the industry. Except from Marlboro, PMI has other brands like L&M, Chesterfield, Philip Morris, Parliament and Virginia Slims.
As those cigarette brands are already well known, the company does not need to spend a lot of money on promotion.

Financial aspect Despite the fact that the recent results do not seem particularly good, Philip Morris had proven itself as a company that provides sustainable growth. They generate sufficient amount of cash to invest it in R&D, to reward its shareholders and repurchase their own common stock.

Workforce
Another strong side of PMI is the employees. It employs over 78,000 people in different offices all over the world: there are brunches of PMI in Switzerland, Spain, Russia, U.S., Thailand. Employees are rotated in different departments and brunches; this creates a very professional workforce. Everybody who works in the company constantly undergoes training sessions, attends seminars and worker's evaluation occurs every three months. Apart from that, PMI is famous for it's excellent working conditions and generous payroll system, which keep the workers very motivated. All of the extra cost of the workers are covered by the company: insurance, rent costs, if a worker had been rotated from one country to another, corporate car, employees' children education in private schools. PMI headquarters has numerous facilities to make the employees feel comfortable at their working place. All those working aspects create an environment where employees are willing to achieve goals and do their best to stay in the company.

R&D and New Product Development
While most companies had been looking into the development and production of e-cigarettes, Philip Morris went beyond that: after spending over $2 billion (CHF1.87 billion) and over a decade, the company introduced iQOS – a product that reduces the harmful effect of smoking by heating the tobacco rather than burning it. This will provide the smokers with an experience very similar to smoking the conventional cigarette, but with much fewer negative consequences.

The management believes that the sales of this product will reach 30 billion units by the end of 2016, and the revenue will hit approximately $700 million.

Reputation/ethics
PMI is concerned about the global warming and energy consumption. Also the company supports small farmers who are their suppliers and spends large amount of money on R&D in order to reduce the harmfulness of cigarettes. All those things improve company's image.

Weaknesses

Legislation/Bans
So far the main weaknesses are linked to the arising governmental regulations regarding tobacco products. Those new policies prevent PMI from increasing this sales, because the aggressive promotion and marketing are not allowed, therefore the business cannot assess it's real sales potential.

Opportunities

New Markets
Although the new regulations and anti-tobacco activist are doing their best to discourage the general public from smoking, PMI still manages not only to survive, but also even to increase sales through the markets of Asia, South America and Africa. Another large and quickly growing market is Russia and Eastern Europe, where the anti-smoking programs are not so developed yet, and the governmental regulations are not yet strict.

Globalization
Other opportunities rose from globalization: PMI could take advantage of a cheap labor and production cost offered in the third world countries like China or Nepal. These new factories helped the company to cut costs, therefore increase the profits, and also promote the products in those new geographic areas and get a new market share.

New Products iQOS, that will appear in Italy in Japan starting from the beginning of next year, might become an outstanding success. This harm-reducing product has a distinguished competitive advantage compared to other e-cigarettes on the market: in provides the user with a sensation of smoking a real cigarette without the harmful effects on the lungs.

Threats

Anti-Tobacco Activists
The biggest threat of PMI is the increasing amount of anti-tobacco activists, a growing awareness of smoking harmfulness and changing legislations. Governments are under the pressure of WHO and other non-governmental organizations. There is a big risk, that there will be a global ban of smoking in public places, the introduction of plain package or a new age limit for smokers. All those factors can be potential threats to the business. The latest suggested regulation, which was brought up by the EU parliament, was regarding the ban for flavored cigarettes and slim cigarettes. Currently this directive was not approved, but what will happen in a few years, when PMI lobbyists will no longer be able to postpone it? Philip Morris might lose some part of its female market, and it could significantly affect company's revenues in future.

Wrong Investment
Philip Morris had recognized the opportunity in the reduced-harm tobacco products and spent billions to design iQOS, which is supposed to become an outstanding success. But what if the whole e-cigarette trend will not last longer than for a couple of years, and in the end, the smokers will return back to the conventional cigarette or will quit smoking completely? Obviously, there are people who are specialists in the industry and analysts who are good at predicting the future, but sometimes, things do not work exactly how they are supposed to. Tomorrow one of the leading pharmaceutical companies might come with a magic potion or a pill, which you take once and forget about your nicotine or any other sort of addiction, and then tobacco industry might disappear within a few years.

SWAT Analysis: British American Tobacco

Strengths

Products and Brands Diversity
British American Tobacco is considered as the “most international” company in the industry. Their portfolio consists of over 300 brands, such as well known Dunhill, Lucky Strike and Kent and also includes a variety of other tobacco products: cigars, roll-your-own cigarettes, pipes, smokeless tobacco and electronic cigarettes.
In 2013 BAT was the first international company to launch its own E-cigarette: Vype. It was designed by CN Creative, a company acquired by BAT in 2012. The company was the first one to recognize the opportunity in this new product on a large scale. Starting from January 2014, Boots pharmacy chain and LloydsPharmacy started the sale of Vype in their stores in the UK, as an alternative for normal cigarettes and a tool that helps people to quit smoking completely.
Apart from e-cigarettes, British American Tobacco has a large market share in the market for harm reduction products, such as Snus, which is very popular primarily in Scandinavian countries.

Geographical Reach
BAT is well diversified all over the world: the company has 82 production plants in 64 countries. It has a very strong position in the markets that are hard to reach for the competition.

Weaknesses

General Financial Situation
If we look at the recent financial results, British American Tobacco has not been doing so great in the past few years. There are multiple reasons for this: decrease in total volume of cigarettes sold, very high taxes, lots of acquisitions, change in regulations which does not allow the company to market their products properly.

Opportunities

New Demand
While the general demand for cigarettes had been decreasing in the past years, many smokers had started to switch to tobacco products with lower nicotine content or e-cigarettes. Health concerns regarding smoking might encourage some people to start using the reduced-risk nicotine products and this creates an opportunity for potential growth. The global smokeless tobacco is estimated to worth $2 billion, the sales of snuff increased by 30% in the past five years, and by introducing its own snuff under the brands like Lucky Strike or Peter Stuyvesant, BAT might have discovered a new segment for growth.

Threats

Health Concerns
The negative effects of consumption of tobacco products become more and more obvious to the general public, more people decide to quit smoking and overall future of the industry is not very clear. The risks associated with the usage of e-cigarettes are yet not discovered, but at some point in the past, smoking normal cigarettes was also considered safe.

Lawsuits
Currently, BAT is involved in various court cases. Some of these cases are filed by people, who suffer from irreparable damage of their respiratory or cardiovascular systems due to the consumption of tobacco products, other cases are of larger scale: Nigerian government decided to sue three major international tobacco companies, including BAT for $44 billion to compensate the harm that they did to the society.

Legislation/New Regulations
There is already a large number of new laws that were introduced all over the world regarding smoking: starting from the 60’s, when the population started to become aware of the negative effects of smoking and the first researches had proven the harm which tobacco products do to human bodies, the rules regarding smoking and selling tobacco products kept on becoming more and more strict. The most recent one is the introduction of the plain packaging: all the cigarette packs will have a relatively similar plain design, with a brand name and a pictorial warning about the harmful effects of smoking. According to the Department of Health of Australia, the number of people smoking in 2013 decreased by 3,4%, after the plain packaging was introduced in the beginning of 2012.4 Government of other countries are currently considering the introduction of a standardized plain packaging, and starting from 2016 and 2017 this new requirement night come into effect in the UK and Ireland. If that would be the case, tobacco companies, including BAT, will have to find a different approach to market their products.
E-cigarettes had not yet been proved to be harmful, but it is possible that within a decade some long-term effects of inhaling e-liquids will be discovered, and then governments and NGOs, like WHO will take measures and put restriction on the production and sales of electronic cigarettes.

Timeline of New Legislations Regarding Tobacco and % of people Smoking in Australia

Healthy Lifestyle
In the past 20 years our society tends to become more and more concerned about the general health: people want to eat well, exercise more, stay away from unhealthy habits, live a long and happy life. Food industry had been slowly transforming in order to provide health benefits for the consumers, people finally came up to the realization that fast food, transfats and GMOs are bad. It is very likely that if this trend continues, in 20 or 30 years people in the developed countries will no longer be willing to poison themselves with Nicotine in any form, and the demand for products like conventional cigarettes or e-ciggs will decrease dramatically. This factor should be considered not only by BAT, but by tobacco industry as a whole.

Sources

Appendix

BAT Cash Flow

BAT Balance Sheet

BAT Income Statement

PMI Cash Flow Statement

PMI Balance Sheet

PMI Income Statement