The UK government's plan to ban in-store displays of cigarettes is unlikely to have a material impact on volume, but plans to introduce plain packaging could encourage trading down. We are maintaining our industry thesis and our fair value estimates for the international tobacco manufacturers, but may revise our assumptions if plain packaging is introduced.
The UK government announced Wednesday that it plans to ban in-store displays of cigarettes in England from April 2012 for large stores and April 2015 for smaller format stores. Such measures are already in place in Scotland, as well as other markets, and the evidence so far is that the absence of in-store promotions has minimal impact on industry consumption. In fact, we think Imperial Tobacco (IMT) could be the winner from such legislation, as competitors' inability to promote price discounts could set in stone the firm's industry-leading market share in the United Kingdom.
Further plans to promote plain packaging are of more concern to us, however, as we think this could lead to trading down. If this occurs, this would also play into the hands of Imperial Tobacco at the expense of British American Tobacco (BATS) and Philip Morris International (PM), as Imperial's product portfolio contains more discount brands than those of its rivals. However, we think legislation to introduce plain packaging could run aground on intellectual property grounds, and we think such a ruling is a low-probability outcome.
We have analysed the effect of numerous variables on cigarette demand, and we think the most effective tool for reducing consumption is pricing. We would be more concerned about large excise tax increases than we are about this announcement. Nevertheless, the announcement is a reminder that regulators and public health officials are likely to clamp down further on the tobacco industry in the medium term, and with most tobacco firms currently trading slightly above our fair value estimates, we think the market may be underestimating the industry's risks. The dividend yield of around 6% on domestic players Altria (MO) and Reynolds (RAI) is still attractive in the current low-interest-rate environment, however.
