UK. British tobacco company Gallaher Group today reported a +7% rise in first-half underlying profits for the period ended 30 June and said it was on course to meet its target of up to +10% earnings growth for the year.
Gallaher reported first-half 2003 pre-tax profits before exceptional items of £241 million (US$378.7 million) – towards the top of analyst forecasts.
Gallaher, whose cigarette brands include Benson & Hedges, Silk Cut and Mayfair in the UK, saw profits ease in Britain and the former USSR countries, but saw growth across most of continental western Europe.
But UK profits fell due to higher personal allowances on imported cigarettes (a big factor in surging sales of cigarettes on UK-France ferries) and a big rise in marketing ahead of a UK February advertising ban.
Effective last October, UK Customs & Excise limits for personal consumption rose to 3,200 cigarettes (200 cigars, 400 cigarillos, and 3 kg smoking tobacco).
This increase together with the on-going high levels of UK tobacco taxation, drove an underlying annualised decline in UK duty paid cigarette market volumes of around -5% in the first half. Gallaher’s UK volumes declined 8.2% to 10.0 billion cigarettes.
Profits in another key market, the CIS, fell -26% due to the weak dollar, higher excise taxes and increased marketing. But this was offset by a strong performance in key European Union countries, such as France, Spain, Italy and the Balkans and growth outside Europe, notably in Asia Pacific, and the company saw volume growth across the whole group of +5.2%.
In Asia Pacific, Gallaher said that duty free plus Chinese and Japanese domestic business had helped grow regional sales volumes +5.6%, despite the impact of SARS. Consumer awareness of the Sobranie brand had grown well, the company said.
In certain important Continental European markets, excise duty increases continue to have an impact on prices, sales and margins, Gallaher said. These included the introduction of the second stage of the extraordinary duty increase (“anti-terror tax”) and the proposed €1 per pack cigarette excise tax increase in Germany. In France, cigarette taxes increased by +8% in January 2003 and, as revealed by The Moodie Repport, will be followed by a further sharp increase next week. Furthermore, the French Health Ministry has proposed that prices should double over the next four years, from €3.90 to €7.50.
For interested readers, Gallaher’s edited financial and operating review follows:
United Kingdom
While Gallaher’s UK cigarette market share marginally improved in the first half of 2003, UK turnover decreased +6.3% to £1,758 million.The decrease largely reflected lower cigarette volume sales, down -8.2%, to 10.0 billion sticks, and downtrading by consumers to cheaper cigarettes, partially offset by price increases (UK government duty and Gallaher’s own price increases).
The volume decline primarily reflects the phasing of trade sales at the end of 2002 and a reduction in the size of the UK duty paid market (estimated at around -5%) which includes the first time impact on the first half results of the increase in duty paid allowances for UK travellers returning from the EU announced by the UK Government in October 2002. Excluding the effect of the phasing of trade sales, Gallaher’s underlying cigarette volume sales were down some -3.5%.
UK net turnover reduced -5.9% to £285 million.
UK adjusted EBITA was -1.2% down at £143 millionwith the decrease in net turnover largely offset by lower costs, largely volume related, despite the marketing investment placed behind brands ahead of the introduction of the advertising ban in February 2003. This reduction in costs resulted in an improved adjusted EBITA margin of 50.3%, compared to 47.9% a year ago.
UK operating profit was down by £19 million to £125 million – the reduction mainly reflecting the UK exceptional charge of £17 million in 2003.
Continental Europe
In 2003, Continental Europe delivered a strong underlying performance, growing turnover by +14.7% to £2,162 million, assisted by the strengthening of the Euro. Volume sales were slightly down at 22.1 billion. Pro-forma volume growth was +1.7%, after adjusting for the reallocation of the legacy Austria Tabak Africa and Middle East business to the Rest of World division from July 2002, despite the loss of Swedish contract manufactured (“SCM”) volumes in 2003.
Continental Europe net turnover increased +13.5% to £1,275 million comprising: tobacco net turnover of £209 million and distribution net turnover of £1,066 million. Adjusted EBITA grew +15.3% to £123 million of which £90 million arose from the tobacco operations and £33 million came from the distribution businesses.
In 2003, the group’s share of losses arising from its joint venture with RJ Reynolds offset its share of profit from its associate, Lekkerland-Tobaccoland.
Efficiency improvements in the distribution businesses underpinned a growth in distribution EBITA margin to 3.1% from 2.8% a year ago. The tobacco operations adjusted EBITA margin, after adding back inter-company sales to the distribution businesses, was 34.3%. Reflecting the weighting of the distribution businesses within the divisional results, thje region’s adjusted EBITA margin was 9.6%.
Continental Europe operating profit was £87 million, after deducting the exceptional charge of £1 million in 2003.
The success of the organic businesses – Gallaher has taken price increases, and grown market share, in certain European markets – together with Euro currency benefits on translating Continental Europe earnings into Pounds Sterling, have enabled Gallaher to: offset the initial costs arising from the Gustavus acquisition in July 2002; compensate for the start-up costs of Reynolds-Gallaher International, which commenced trading in July 2002; and, absorb the adverse currency impact on margins of operations outside the euro-zone (particularly in Sweden and Central and Eastern Europe).
Commonwealth of Independent States
In the Commonwealth of Independent States (CIS), strong volume growth in Kazakhstan and Ukraine more than offset the reduction in Russian volume sales due to the phasing of trade sales ahead of the 1 January excise duty increase, and the planned extended factory holiday period.
Despite the backdrop of a substantially weakened US Dollar (Gallaher’s CIS sales are largely US Dollar denominated), this volume growth of +11.2%, to 36.3 billion sticks – and Gallaher’s growing presence in the Russian premium sector – resulted in a +8.8% increase in CIS turnover to £164 million, and an increase in CIS net turnover to £130 million.
CIS EBITA was £14 million and operating profit was £9 million, reflecting the significantly adverse impact of the translation of CIS earnings into sterling and margin pressure, including the first time impact on first half results of the incremental marketing investment in Russia which commenced in the second half of 2002. Margins were also reduced by the wider than expected industry absorption of the substantial increase in cigarette taxation in January – compounded by the strength of the rouble in real terms relative to the US dollar.
EBITA margin declined to 10.5% from 14.6% reflecting these factors.
Management anticipates that the distribution of CIS full year earnings will return to this region’s traditional trading pattern of approximately one third of annual earnings being attributable to the first half.
Rest of World
Gallaher’s Rest of World (RoW) turnover increased +15.3% to £241 million, and RoW net turnover grew +28.7% to £62 millionmainly reflecting favourable exchange movements in Ireland and sharply increased volumes in Asia Pacific, Africa and the Middle East – in part as a result of the inclusion of some Africa and Middle East (AMELA) volumes previously reported within CED. RoW volume sales totalled 5.3 billion cigarettes. Pro-forma RoW volume growth was +10.3%.
In Ireland, manufacturer’s price increases, currency benefits and a tight control of operating costs more than compensated for lower volumes in the reduced Irish market following the significant increase in duty at the end of 2002. The AMELA operations have suffered from adverse foreign exchange movements with invoiced sales being denominated in the weakening US dollar, and much of the cost base in the strengthening euro.
RoW adjusted EBITA rose +29.5% to £25 millionand the adjusted EBITA margin increased slightly to 39.3%. RoW operating profit was £5 million- the reduction mainly reflecting the RoW exceptional charge of £20 million in 2003.
OPERATING REVIEW
Group
Gallaher’s strategy is to create value for its investors through the development of a balanced portfolio of interests in established and emerging markets across Europe and Asia – organically and through acquisitions and strategic alliances – capitalising on its proven ability to build brand equity.
The group’s growth was underpinned by its leading positions in certain Western European markets in the first six months of 2003. Gallaher’s brands performed strongly, with total volumes increasing +5.2% to 73.7 billion cigarettes, despite tough competitive conditions in some key markets.
The group continued its Eurasian expansion with gains in market share in Southern Europe and the CIS, and it has entered the Polish market following the completion of the acquisition of KT Merkury in July 2003.
United Kingdom
In the UK, Gallaher aims to increase its shares of the growing value cigarette sector and the handrolling tobacco market, and to defend its leading positions in the premium cigarette and cigar sectors – achieving an appropriate balance between sales volumes and the margins achieved on those volumes.
Gallaher’s leading positions in the UK premium cigarette and cigar markets benefited from investment in a final round of advertising in the run-up to the commencement of the ban on 14 February 2003. This expenditure is expected to underpin the long-term brand equity of Benson & Hedges, Silk Cut and Hamlet.
The increase in the government’s guidelines for personal tobacco import allowances for travellers returning from the EU, together with the on-going high levels of UK tobacco taxation, drove an underlying annualised decline in UK duty paid cigarette market volumes of around -5% in the first half of 2003.
Cigarettes
– Moderate downtrading from the premium and mid price sectors into value price cigarettes continued in the first six months of 2003.
The respective shares of retail sales accounted for by each price sector were: value: 55.8%; mid price: 11.6% and, premium: 32.6%.
Gallaher’s UK retail market share increased to 38.3% from 37.7%. The Group’s principal UK houses, Benson & Hedges and Mayfair, both performed well.
Gallaher’s UK volumes declined -8.2% to 10.0 billion cigarettes, reflecting the reduction in the duty paid market noted above and the phasing of trade sales in December 2002 ahead of the introduction of new packaging with larger health warnings.
Excluding the phasing of trade sales, Gallaher’s underlying volumes reduced some -3.5%.
Benson & Hedges Gold, the UK’s leading premium cigarette, broadly maintained its share of the sector at 26.7%. The Benson & Hedges house was strengthened by the launch of a new, reduced tar, brand Silver at the end of February. Together, Gold and Silver maintained the Benson & Hedges house share of the total market at 9.1%.
Mayfair performed strongly, increasing its share of the total market to 10.1%, and volumes by 21.3%, benefiting from competitive pricing and the growth of the value sector. The brand’s share of the value sector has grown to 18.2% – underpinning growth in Gallaher’s sector share to 32.9%.
Investment in the promotion of Gallaher’s brands to smokers at the point of sale and to the trade has continued. The Group is well positioned at the point of sale in the UK. In the first half, the majority of consumer cigarette purchases through merchandising units were made through Gallaher’s units – an important advantage in a market where communication with smokers is now largely restricted to the point of sale.
The Group strengthened its sales force through additional recruitment and the introduction of automated information systems across the field sales force.
Cigars
The UK cigar market declined some 6% in the first six months of 2003, and the consumer trend from the higher margin large cigar sector to the small cigar sector continued.
Gallaher increased its lead of the UK cigar market with a 47.1% share of sales to consumers. Original Hamlet grew its lead of the large cigar sector with a share of 54.4% and Hamlet Miniatures increased its share of the growing small cigar sector to 32.2%. Hamlet Aromatic gained a 1.3% share of the small cigar sector, despite only having been launched in December 2002.
Tobacco
Gallaher maintained its position in the handrolling tobacco market. The Group’s share of consumer sales was 31.7% driven by the continued success of Amber Leaf, which increased market share to 15.8%, offsetting Old Holborn’s market share decline.
Gallaher extended its lead of the declining pipe tobacco market, growing its share of sales to consumers to 50.3%. The number one pipe tobacco brand Condor underpinned the Group’s position, together with Clan and Mellow Virginia. These brands occupy three of the four leading brand positions.
Continental Europe
In Continental Europe, Gallaher aims to defend its market leading positions in Austria and Sweden – balancing volumes and margins – and to grow share elsewhere.
Gallaher traded robustly in Continental Europe in the first six months of 2003, despite the above inflation increases in cigarette taxation that have led to declines in total market volumes in several European states – including France and Germany. Going forward, the substantial differentials between cigarette taxation and prices between certain European markets may lead to an acceleration in the growth of non-domestic market duty paid consumption in high tax markets.
The Group’s Continental European volumes of 22.1 billion cigarettes, represent an underlying increase of +5.7% on the comparable period in the previous year.
Tobacco Products
Gallaher maintained its lead of the Austrian cigarette market with a 46.2% share of sales. The group’s key growth brand Memphis Blue increased market share to 6.1%. This brand’s growth was more than offset by the continued expected decline in the market share of traditional local brands and lower overall wholesale market volumes. In Sweden, Gallaher maintained its leading cigarette market position with a 39.7% share of sales to consumers. Level again performed well, growing market share to 7.4%. Volume sales of this brand increased by over 40%.
The Group has ceased contract manufacturing in Sweden due to the closure of its factory at Malmo in 2002, which produced 0.8 billion cigarettes under contract in the first half of that year.
Gallaher’s moist oral snuff operations continued to make solid progress. Gustavus has benefited from increased national distribution coverage – up to around 60% by June. Volume sales continue to increase, and Gustavus had established a 1.3% market share by June 2003.
Elsewhere in the EU, Gallaher’s trading performance was robust. In Germany, the Group performed well – increasing its share of the resilient generic cigarette sector, while maintaining its branded cigarette market share.
Gallaher broadly maintained cigarette market share in Greece at 5.1% and increased its share of the handrolling tobacco market to 38.4% due to growing demand for Old Holborn.
Sales of the Virginia blended Benson & Hedges Metal range underpinned the Group’s success in Western Europe. Strong volume growth from Reynolds-Gallaher International drove an increase in the Group’s total first half cigarette market shares to: 3.1% in France; 3.1% in Italy; and, 1.8% in Spain. The Group also strengthened its position in the French cigar market with the launch of Hamlet Fine Aroma in May.
The Group has continued to develop its operations in Central and Eastern Europe. Total volumes in these markets increased by 3.3% and Gallaher now has a pan-Balkan market share of 4.8%. Foundations for further growth have been strengthened by the opening of an office in Serbia, and trading commenced in Poland in July following the completion of the acquisition of KT Merkury.
Gallaher’s acquired brands in Poland – including Brydzowe and Viva – hold a market share of 1.7%. The Group intends to build on the base provided by these brands by launching selected international cigarettes from its comprehensive brand portfolio – utilising its proven ability to develop strong positions in emerging markets.
Distribution
Gallaher’s distribution businesses performed well in the first half of 2003.
In Austria, the improvements that were made to TOBA’s warehouses and information systems in 2002 underpinned enhanced margins, which more than offset the impact of lower first half cigarette market volumes.
In Germany, ATG – the vending company in which Gallaher has a 63.9% holding – continued to make good progress. The company gained share of both the total and vending markets – assisted by: the acquisition of new vending sites; continued rationalisation of existing sites; the introduction of enhanced technology machines; and, advantageous vending pack pricing relative to retail.
The ongoing implementation of cost saving initiatives at Lekkerland-Tobaccoland – an associate in which Gallaher has a 25.1% holding – is partly offsetting the effect of lower German cigarette market volumes, and the impact of the German government regulations regarding can recycling.
Commonwealth of Independent States
In the CIS, Gallaher aims to grow regional market share while increasing the proportion of its brands sold in the intermediate and higher priced sectors across the region.
The group continued to trade strongly in the CIS in the first six months of 2003. Gallaher increased regional scale: growing market share in Russia, Kazakhstan and Ukraine; and, increasing total volumes 11.2% to 36.3 billion cigarettes. Reflecting the group’s focus on intermediate and higher price sectors, CIS hard box, filter, cigarette volume sales grew +23.7%, while lower margin oval volumes were down over 50%.
Russia
In Russia, Gallaher increased its share of the total market to 14.5%. Notwithstanding this growth in sales to consumers, the extended holiday period at the Moscow factory in January resulted in a -8.3% reduction in invoiced sales volumes, which included a planned strategic reduction in non-filter oval sales of over 70%.
Within its sales mix, Gallaher continued to increase the proportion of its brands sold in the intermediate and higher price sectors. Sales in these sectors accounted for 92.3% of the Group’s Russian volumes, reflecting an increase in hard box, filter, cigarette volume sales of +13.2% in the first half 2003.
LD maintained market share at 5.2% during the first half, underpinning growth from Sobranie, St George and Troika.
Gallaher increased its share of the premium sub-sector to 2.2% as a result of improving distribution and the marketing investment placed behind its brands, which commenced in the second half of 2002. By June 2003, the group’s share of the premium sub-sector was 2.8%.
The group is continuing to build brand equity in Russia. In June, the Sobranie house was strengthened by the launch of the aspirational White Russian brand, and a new Slims variant of LD was launched. – Kazakhstan
Gallaher grew market share substantially to 27.9% in Kazakhstan. Volume sales increased over +50% driven by strong demand for the Group’s brands including Sovereign, LD, Novost, and Sobranie.
Sovereign extended its market leading position, growing share to 14.4% and LD increased market share to 6.4%.
Ukraine
The Group grew its share of the Ukrainian market to 11.2%. Volume sales increased sharply as brands including LD, St George and Troika gained market share.
Rest of World
In its Rest of World division, Gallaher seeks opportunities for growth in Asia Pacific and AMELA, while defending its leading position in the high margin Republic of Ireland market – balancing volumes and margins.
Gallaher grew Rest of World volumes to 5.3 billion cigarettes.This represents a pro-forma increase of +10.3%.
Republic of Ireland
Trading conditions Ireland were challenging in the first six months of 2003, with volume sales of 1.4 billion cigarettes. Total market volumes declined following the substantial above inflation increase in excise tax that took place in December 2002, while Gallaher’s share of total shipments was impacted by the phasing of trade sales that occurred ahead of the duty increase.
Gallaher’s trading performance remained resilient. The Group maintained its lead of the cigarette market, albeit with a reduced share of sales to the trade of 48.9%. Gallaher maintained its leadership of the cigar market with a 71.2% share.
AMELA
Gallaher grew pro-forma volume sales in Africa and the Middle East by 24.0% to 3.2 billion cigarettes. Strong growth in Africa more than offset a fall in sales to the Middle East relating to the conflict in the region.
In Africa, the Group has maintained its leading cigarette market position in Guinea and grown volumes in certain other markets, including Nigeria.
In addition, the Group produced 0.5billion cigarettes under contract.
Asia Pacific
In Asia Pacific, Gallaher has continued to build consumer awareness of the Sobranie brand and develop relationships with its industry partners.
The group grew regional sales volumes +5.6%, despite the impact of SARS, due to solid performances in Japan, duty free, and China.
Since last year’s signing of a letter of intent with the China National Tobacco Corporation, together with the State Tobacco Monopoly Administration (“STMA”), excellent progress has been made by the Gallaher and Shanghai Tobacco project team towards reciprocal manufacturing and distribution agreements in China and Russia. Following the signing of a heads of agreement in March this year, the two companies have successfully concluded negotiations on license agreements for each market, which are now awaiting formal approval from the STMA.
Manufacturing
Gallaher’s manufacturing strategy is continuously to maximise value from the group’s wider operational base through maintaining forefront of operational efficiency, while maintaining the flexibility required to meet changing market demands and to support the Group’s marketing focused approach.
As part of this strategy, the Group conducted a review of its European operations, and announced plans in May to cease manufacturing in the Republic of Ireland and to reduce jobs in the UK and Austria.
In the first half of 2003, Gallaher increased Group cigarette productivity +4.1% – reflecting improvements in the UK, Continental Europe, and the CIS. This enhanced productivity and increased efficiency – particularly in the use of leaf – underpinned a -4.2% reduction in real term Group cigarette unit costs, more than offsetting the effect of the increased proportion of hard box, filter, cigarettes in the CIS.
United Kingdom
Productivity at Gallaher’s UK cigarette factory in Lisnafillan increased +10.7%, driven by greater usage of the ultra high speed king size machines installed in 2002, and the addition of two new longer length complexes – one ultra high speed and one mid-speed – in the first half of 2003. This enhanced productivity underpinned a -5.3% reduction in real term unit costs.
The ongoing success of the Amber Leaf flip top pack impacted productivity and unit costs at the Lisnafillan tobacco factory. Productivity reduced -1.3%, and real term unit costs increased +2.4%.
Productivity at Gallaher’s Cardiff cigar factory increased +13.0%, assisted by the investments in machinery that have been made in recent years. This improvement in productivity underpinned a -4.8% reduction in real term unit costs.
Continental EuropeThe efficiency of Gallaher’s Continental European cigarette factories continued to progress in the first half, due to ongoing organisational and technical improvements, including those arising from the transfer of Swedish volumes to Austria in 2002. Productivity increased +3.6%, underpinning a real term reduction of -4.8% in unit costs.
Following the completion of the acquisition of KT Merkury in July, Gallaher has initiated a programme of investment in new machinery to modernise the factory in Gostkow, Poland.
Commonwealth of Independent States
Notwithstanding the extended holiday period at the Moscow factory in January, the Group’s manufacturing facilities in the CIS substantially increased total half year output to meet the growing demand for its brands.
Productivity in the CIS increased +3.4% as a result of higher efficiencies and investment in new technology to meet the higher proportion of hard box, filter, cigarettes and premium brands. This change in mix contributed to a 1.8% real term rise in unit costs.
Gallaher’s flexibility and ability to meet the growing demand for its products – including premium cigarettes – has been enhanced during the first half by the installation of new machinery, including primary processing equipment in Ukraine and additional cigarette production lines in Kazakhstan.
OUTLOOK
Group trading remains in line with expectations for the full year.
Gallaher’s performance in the first half of 2003 again demonstrates the benefits of the Group’s Eurasian strategy – to build a balanced portfolio of interests across Europe, the CIS, Central Asia and Asia Pacific.
LEGAL AND REGULATORY ENVIRONMENT
Regulation
The global tobacco market has been subject to significant regulatory influence and/or voluntary agreements in recent years. The Group has a long history of managing its business successfully within a regulatory climate. In recent years, the Group has reduced its susceptibility to regulatory changes in any single country by expanding its international operations. However, it is possible that regulations in any of its key markets could have an adverse effect on the Group’s sales and operating performance.
The World Health Organisation has adopted a Framework Convention on Tobacco Control. The tobacco control treaty includes provisions governing, amongst other matters: advertising and sponsorship; tax and price increases; labelling; illicit trade; and, environmental tobacco smoke. Within the EU, a Directive concerning the manufacture, presentation and sale of tobacco products was adopted in 2001 and is currently being implemented into EU Member States’ national law.
Its provisions include: matters relating to ingredients disclosure; the prohibition of descriptors suggesting that a particular tobacco product is less harmful than others; new and larger health warnings; rules allowing for the use of colour photographs or other illustrations to depict and explain the health consequences of smoking; tar, nicotine and carbon monoxide ceilings; an assessment of the health effects of the smoke yield of other substances; and, a proposal for a common list of ingredients.
The EU adopted a Recommendation on the prevention of smoking and on initiatives to improve tobacco control in 2002. Its contents include: preventing tobacco sales to children and adolescents; prohibiting certain forms of advertising and promotion; obliging tobacco manufacturers to disclose their expenditure on tobacco advertising; and, providing adequate protection from exposure to environmental tobacco smoke. Member States may decide whether or not to comply with this Recommendation.
In 2003, a EU Directive relating to the advertising and sponsorship of tobacco products was adopted. Its provisions include the prohibition of tobacco advertising: in the press and other printed publications; in radio broadcasting; in information society services; and, through tobacco related sponsorship, including the free distribution of tobacco products. Member States shall comply with this Directive by 31 July 2005 at the latest.
The EU has also indicated that it is to develop an initiative to ban smoking in the workplace.
The 10 European countries that will join the EU in May 2004 (“EU Accession Countries”) must comply with the existing laws of the EU at the time of joining unless transitional arrangements have been previously agreed.
In the UK, the Tobacco Advertising and Promotion Act was adopted in 2002. The Act prohibited the advertising and promotion of tobacco products including billboards, press, and free distribution of samples from February 2003, and in-pack promotion schemes from May 2003.
The Act also bans sponsorship by tobacco companies from July 2003, although transitional provisions allow an exemption for ‘exceptional global events’ until July 2005. Point of sale advertising and brand sharing regulations are expected to be published shortly. In the Republic of Ireland, the Public Health (Tobacco) Act was adopted in 2002, giving wide-ranging powers to the Office of Tobacco Control.
In January 2003, the Minister for Health and Children announced that he would repeal all but one of the provisions of the Act (that relating to smoking in the workplace, including bars and hospitality premises), as they had not been notified to the EU under the Technical Standards Directive. In August 2003, a new Bill was published giving effect to two EU Directives and a EU Recommendation relating to tobacco. The Bill includes provision for a comprehensive ban on tobacco advertising sponsorship and measures relating to the manufacture and sale of tobacco products.
In Germany, the Government introduced a law on the protection of young people in 2002 whereby the sale of tobacco products to persons under 16 years is prohibited. In addition, from 2007 cigarettes may only be bought from vending machines which have youth protection technology installed i.e., consumers will have to verify their age, for instance, by using age encoded chip cards.
In France, the Government enacted a law in 2003 seeking to restrict tobacco consumption among young people. The law prohibits: the sale of cigarettes to children under 16 years; the free distribution of cigarettes to minors; and, packs of less than 19 cigarettes.
In the Netherlands, the Government has recently introduced tobacco ingredient disclosure regulations. In August 2003, Gallaher and Philip Morris International commenced a joint legal challenge to the Dutch regulations, which, Gallaher believes, do not provide adequate protection for brand recipes. Other tobacco companies including British American Tobacco and Japan Tobacco International have also commenced legal proceedings.
In Russia, a federal law on restrictions on the smoking of tobacco came into force in 2002. The legislation prohibits: smoking in some public places; the sale of cigarettes to those under 18 years of age; and, the sale of loose cigarettes or packs containing fewer than 20 cigarettes. Furthermore, from January 2003, the production and import of filter cigarettes with smoke yields exceeding 14mg of tar and 1.2mg of nicotine was prohibited, and tobacco products must display a general and rotational health warning and tar and nicotine smoke yields.
In the Ukraine, the Parliament approved a Bill in July 2003, restricting tobacco advertising in the printed media and prohibiting it entirely on television and radio.
Taxation
In 2002, the EU adopted a Directive increasing the minimum excise rates on all tobacco products. The provisions also include the introduction of a minimum excise burden of e60 per thousand cigarettes on the most popular price category of cigarettes from 1 July 2002, increasing to e64 per thousand cigarettes in July 2006. For certain Member States, transitional periods to comply with the new cigarette rates are allowed by the Directive. Member States may also introduce a minimum excise duty on lower priced cigarettes provided that such excise duty does not exceed the amount on the most popular price category.
EU Accession Countries will be required to implement significant duty increases in order to comply with the minimum cigarette excise tax requirements. Many have been allowed transitional periods – the longest until January 2010 – in which to comply. The maintenance of the current controls on personal imports from Accession States into existing EU States could have a significant impact on sales in neighbouring countries such as Austria and Germany in the transitional periods. The Austrian Government for instance is committed to maintaining the 25-cigarette import limit for Austrians travelling to such EU Accession Countries. Any increase to the limit could result in significant market decline.
In the UK, tobacco duty was raised in line with inflation in April 2003. The impact of high taxation in the UK cigarette market, resulting in high prices, has led to reduced annual industry volumes, greater price competition, trading down by consumers to lower price cigarette brands, and a growth in non-UK duty paid cigarette consumption (both smuggled and legitimate cross border purchases).
Gallaher believes that the wide price differentials between the UK and Continental Western Europe and other parts of the world have led to a significant smuggled market for legitimate and counterfeit cigarettes. There has also been an increase in the amount of non-UK duty paid cigarettes and handrolling tobacco being purchased by travellers returning to the UK from the EU.
In certain important Continental European markets, excise duty increases continue to have an impact on prices, sales and margins. These include, for instance, the introduction of the second stage of the extraordinary duty increase (“anti-terror tax”) and the proposed e1 per pack cigarette excise tax increase in Germany. In France, cigarette taxes increased by 8% in January 2003. Additionally, there will be a further tax increase in September 2003. Furthermore, the French Health Ministry has proposed that prices should double over the next four years, from €3.90 to €7.50. In Sweden, the introduction of a minimum excise tax has increased excise payments on lower priced brands by over +8%.
