Slow profit growth to keep European tobacco stable till 2015

The outlook for the European tobacco industry will remain stable over the next 12-18 months, reflecting an expected slowing of operating profit growth to around 4.5%-5.5% versus the previous expectation of 7% growth, Moody's said in its latest Industry Outlook, changing the outlook for the industry to ‘stable’ from ‘positive’ in June 2013.
"We expect to see a further acceleration in declining cigarette sales in the next 12-18 months in most European markets. Volume declines may be larger in more profitable markets, which will have a greater impact on overall industry profitability," said Paolo Leschiutta, author of the report. "Overall, increased regulatory pressure will likely continue to weigh on the operating profits of tobacco companies into 2015."
Within Europe, Moody's expects the decline in cigarette volumes to be greater in southern European countries, where the rating agency expects no, or very slow, economic growth in the period. In addition, Moody's notes that regulatory pressure has increased in the past year, including a smoking ban in Russia, which the rating agency believes will have a significant short-term impact on volumes.
Tobacco manufacturers will probably increase prices to offset increasing pressure on volumes. Price inelasticity remains good, but the current market conditions will constrain price increases.
Moody's expects that developing market growth will help offset sluggish mature markets. Philip Morris International Inc. (PMI, A2 stable) and British American Tobacco plc (BAT, A3 stable) should benefit from their greater exposure to emerging markets and from their earlier starts in investing in non-traditional products. Imperial Tobacco Group plc (Baa3 positive) and Swedish Match AB (Baa2 stable) are more exposed to mature markets but both have diversified products or value brands, which will help reduce the impact of sales declines in those markets.
The nascent e-cigarette market could add to competitive pressure in the industry. However, in the next two to three years Moody's expects these products to represent only 1%-2% of the global cigarette market in terms of volumes, and an even smaller proportion in value terms. Some issuers are moving into the segment via acquisitions in the case of BAT, or product investment (PMI).
Moody's considers that the outlook has more upside potential than downside. If issuers can offset the industry's short-term challenges with growth in emerging markets, possible small acquisitions and price increases, then profit growth might exceed 6% and Moody's could consider changing the outlook back to positive.