Based on Fitch's estimate of an average retail price of $4.45 per pack of cigarettes at the end of 2008, the cigarette manufacturers' pricing actions will result in volume declines of 5% to 7%. Given secular volume declines in the low to mid-single digit range, Fitch anticipates 2009 volume declines in the high single digits to low double digits.
It may take several months for tobacco consumers to adjust to the new pricing, and volume declines are likely to be greatest in the reporting periods following the price increase. In the face of the recession, consumers may make a more concerted effort to cutback their tobacco purchases. Price-sensitive consumers are also likely to switch to value or discount brands from higher-priced premium brands, which would impact the tobacco manufacturers with significant premium skews in their product portfolios such as Altria Group, Inc.'s (Altria) Philip Morris USA and Lorillard, Inc. Reynolds American Inc.'s R. J. Reynolds Tobacco Co. may benefit from trading down considering the value brands in their product portfolio.
Additionally, due to the one-time floor tax, retailers and wholesalers had most likely been destocking to keep inventories as low as possible on April 1, 2009. Some retailers may have increased their retail tobacco prices prior to that date to compensate for the expected one time payment. Both actions would have exacerbated the volume declines experienced by tobacco product manufacturers, but these effects are most likely temporary. After April 1, 2009, retailers and wholesalers presumably restocked to normalized levels, since tobacco manufacturers will be responsible for the increased FET for products delivered after that date.
As consumers adjust to tobacco product pricing and the temporary effects of the floor tax work their way through tobacco manufacturers' results, credit metrics are likely to weaken; however, Fitch expects volume declines to moderate after the pricing actions have taken place, and large tobacco manufacturers are expected to continue to generate significant cash from operations despite the volume pressure. Fitch's ratings incorporate this outlook.
The tax impact on smoking habits is no surprise, added a report by The Wall Street Journal. A CDC policy paper (click here) in 2007 said that says raising the unit price for tobacco products is among "the most highly effective policy interventions" in driving down smoking rates. And the CDC last month published data analyzing trends (click here) between 1998 and 2007 that indicated that smoking prevalence decreased in 44 states.
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