Sector Insight: Cigarettes - Sales down, duty up

Eurobarometer poll of 25,000 people found that 84% support a ban on
smoking in any indoor public space, but only 56% say it should be banned
in restaurants and 40% in bars. Nonetheless, the ban that came into
force in Scotland in March is due to be enforced in England next year,
as the government's latest attempt to force consumers to give up their
habit and improve their health.

The number of smokers in the UK has stabilised in recent years at about
one-quarter of the population. Those still lighting up are estimated to
generate revenue of £12.6bn in 2006 - an increase of 13% since
2001, according to Mintel.

However, it is not as good news for manufacturers as this headline
figure might suggest, for this value growth has come about largely due
to annual duty rises - which means money to the government, not the
brand owners.

Indeed, cigarette volume sales have fallen by 12% over the past five
years, and a further decline could well follow in the coming two years
as the smoking ban in public places moves south from Scotland to
encompass England.

The increase in tax is turning some smokers to less legitimate sources
for their daily fix, which means non-duty paid cigarettes now account
for 16% of the market, taking further money out of the manufacturers'
pockets.

What is more, duty-paid cigarettes are also facing a challenge from
hand-rolling tobacco. This is the one area of the industry experiencing
rising volume sales, up 12.5% between 2001 and 2006 to a value of about
£500m.

The lower price of rolling tobacco is the principal reason for this
growth, with a 12.5g pack of tobacco costing about 15% less than a
packet of 20 cigarettes. As younger smokers have moved to roll-ups to
save money, the sector has begun to shed its old, working-class,
masculine image, and women now make up about one-third of roll-up
smokers, according to TGI.

Trading down

As cigarettes rise in price, so smokers are turning to 'value' brands in
increasing numbers. Volume sales in this price category grew by
three-quarters between 2001 and 2005, and they now account for almost
one-quarter of the market by volume. Premium-, mid- and even low-priced
categories have all seen their share fall over the same period.

This trend is further eroding brands' profits, as lower value is not
being replaced by higher volume: 3bn fewer cigarettes were smoked in
2005 than 2003, as consumption habits have shifted toward lighter use -
fewer than 15 cigarettes a day.

Tobacco manufacturers seeking to boost their bottom lines by luring
rivals' consumers are hamstrung by the fact that tobacco advertising has
been banned since 2003, and stringent regulations on point-of-sale
material have been introduced. One of the few methods of promotion still
open to the manufacturers is the gantry supporting their brands, but few
consumers wait until they are at the point of paying to decide which
brand they will buy.

Meanwhile, the government is continuing to support those trying to kick
the habit and in 2005 invested £14m in anti-smoking campaigns. A
large proportion of smokers want to stop: almost half (47%) tried to
quit in the past year. People with young children are especially
motivated to stop, with 55% having tried to give up in this period.

Amid all these troubles, Imperial Tobacco and Gallaher remain the UK's
two biggest cigarette manufacturers, together accounting for 85% of
volume sales.

Imperial owns the two top-selling brands - Lambert & Butler and Richmond
- as well as Drum tobacco and Rizla rolling papers. It has a presence
not only in the premium sector with Regal and Embassy, but also the
lower-priced bracket with its JPS Superkings brand.

The company has invested in packaging and brand extensions of its
Lambert & Butler and Richmond brands, both of which have grown as a
consequence.

Richmond, its ultra low-priced brand, has seen the strongest growth, in
keeping with the general sector trend.

It has also bought the Windsor Blue budget brand, which it relaunched in
January, positioned as cheaper than Richmond, at £4.04 for a
packet of 20 compared with £4.28 for Richmond.

Gallaher, meanwhile, is the leading player at the premium end of the
market, with Benson & Hedges and Silk Cut, though it also owns the
cheaper Mayfair brand. It extended its B&H brand in 2003 with B&H Silver
as a lower-cost version and B&H Gold as a premium version.

Last September it launched B&H 14s to fit in with consumers' changing
habits. 'The packs are designed to fulfil the exact needs of adult
smokers, as they meet today's average consumption of 14 cigarettes a
day,' says Ben Townsend, corporate affairs manager at Gallaher. 'They
appeal not only to purchasers of 10s and 20s, but also those who smoke
economy brands, but would prefer a premium alternative.'

The trend toward cheaper products is likely to reduce the market's value
growth further. The duty-paid cigarette market is predicted to be worth
almost £14bn by 2011, but this is a 12% decline in real terms,
according to Mintel.

With NPD largely restricted to brand extensions, companies may look to
introduce smokeless nicotine products such as 'snus' - a small tobacco
pouch that is placed inside the user's lip. Imperial, Gallaher and BAT
are all looking into selling snus, though it is currently banned across
the EU except Sweden.

CIGARETTE BRANDS BY MARKET SHARE (%)

Brand Manufacturer 2005 2003 2001

Lambert & Butler Imperial 15.5 15.6 15.3

Richmond Imperial 14.2 11.7 5.8

Mayfair Gallaher 13.3 10.4 7.7

Benson & Hedges Gallaher 9.1 9.3 9.2

Marlboro Imperial 7.3 6.8 5.9

Silk Cut Gallaher 5.7 6.1 7.0

Superkings Imperial 5.5 6.6 8.4

Rothmans Royals BAT 4.6 4.3 5.2

Embassy Imperial 3.7 4.1 4.6

Regal Imperial 3.4 3.9 4.4

Berkeley Gallaher 2.5 3.5 4.7

Sovereign Gallaher 2.4 3.0 3.6

Sterling Gallaher 2.1 1.4 0.7

Dorchester Gallaher 1.8 3.2 3.1

Others 8.9 10.1 14.4

Source: Gallaher



CIGARETTE MANUFACTURERS BY VOLUME SALES AND MARKET SHARE

Manufacturer 2005 2003 % change

Bn sticks % Bn sticks % 2003-05

Imperial Tobacco 23.8 47.1 25.4 47.4 -6.1

Gallaher* 19.2 38.0 19.7 36.8 -2.5

Rothmans UK 2.7 5.3 3.2 6.0 -15.6

Philip Morris** 3.0 5.9 3.4 6.3 -11.0

Others/own-label 1.8 3.6 1.9 3.6 -5.3

Total 50.5 100 53.5 100 -5.6

Source: Mintel *including Japan Tobacco **distributed by Imperial

Tobacco in UK



CIGARETTE SMOKERS BY FREQUENCY OF USE (%)

2005 2003 2001

All users 26.3 27.9 27.3

Heavy users 4.6 5.3 5.4

Medium users 8.2 8.5 9.2

Light users 12.3 12.7 12.3

Non-users 73.7 72.1 72.7

Source: GB TGI, BMRB 2001, Winter 2003 & Quarter 1 2006/Mintel Base:

adults aged 16-plus

ANALYST COMMENT - Ian Bell, Senior research analyst UK and Ireland,
Euromonitor

You can't advertise them, moves are afoot to ban their consumption in
public places, they cause litter and go right against the grain when it
comes to all matters of good health.

In 2006, cigarette manufacturers can at least be confident that they
have retained their position as the UK's public enemy number one, ahead
even of junk food, binge-drinking and bad school dinners.

That said, cigarette sales are likely to top £14 bn in 2006, with
an estimated £3bn more swimming around in the black market. So
even for a sector wrapped up in regulation and losing consumers either
to healthier lifestyles or illicit imports, tobacco remains a major
force in British retail.

But the spectre of a full ban in public places remains, and in a year's
time, businesses will have to cope with an entirely new environment.

Licensed premises that adapt to the new conditions most quickly are
likely to steal a march on their rivals. Beer gardens look set to be all
the rage, with significant investment in outdoor smoking areas.

The latest models will be covered, heated and complete with plasma
screens and audio entertainment, and any cigarette brand that makes
headway in becoming a preferred option in vending machines will give
themselves a big boost.

The question of what constitutes an enclosed space will be a further
bone of contention for the industry, as the more pubs that are able to
serve smokers, the greater their chances of profiting.

What is for sure is that when the fog passes, the UK licensed sector is
unlikely to look the same, with gastro pubs set to boom, and the ban
perhaps spelling the demise of the traditional boozer - and with it that
familiar smoky haze.